Fuel Prices Fall & Inflation Retreats

The Lehmann Letter (SM)

  

Most of us know that gasoline prices have fallen recently. The consumer price index should reflect that when it’s released next week. Falling fuel prices have already affected the producer (wholesale) price index, out today:

http://stats.bls.gov/news.release/ppi.nr0.htm

The Bureau of Labor Statistics reported that April prices fell 0.2%, or 2.4% at a seasonally-adjusted annual rate. Wholesale prices were flat in March, and also benefitted from falling fuel prices.

Producer Prices 

(Click on chart to enlarge)

(Recessions shaded)

As last month’s letter on this topic said:

The chart illustrates the extreme variation in wholesale-price changes from month to month. Recent years are no exception. But you can see that inflation has not surged since the recession.

Why? Because the economy continues to operate with sufficient excess capacity to hold inflation to a minimum. There are so many idle factories, idle machines and idle people - all waiting for the opportunity to get back to work - that business can easily call upon them if it wishes to expand and can do so without offering higher prices for their services. Costs and wages have not risen because there is so much slack in the economy.

As soon as recession gripped the economy in 2008 the Federal Reserve began pursuing a "whatever it takes" expansionary policy. These steps continued and continue to the present day as the Fed has held interest rates near zero in order to drive the recovery forward.

Critics began expressing fears of rising inflation as soon as the Fed embarked on this road. Their theory: A rapid increase in the money supply would generate a rapid rise in prices.

The important point: The Fed's expansionary policy did not occur in a vacuum. Monetary stimulus in a time of full employment generates inflation. Monetary stimulus with mass unemployment does not. It's as simple as that.

The economy remains weak, and we suffer because of that. But tame inflation is a benefit.

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann

Europe's Citizens

The Lehmann Letter (SM)

  

Today's Wall Street Journal has a number of worthwhile articles on the European financial crisis.

Begin with, “How a Radical Greek Rescue Plan Fell Short,” for a historical description of those events:

http://online.wsj.com/article/SB10001424052702304203604577393964198652568.html?mod=ITP_pageone_0

Greek voters rebelled against their government and austerity in last Sunday's election. The electorate said “Enough; we can't meet Europe's demands."

Europe’s response has been stern: No money without reform. See, “Europe Delays Bailout Payment:”

http://online.wsj.com/article/SB10001424052702304070304577393604233164954.html

Spain, on the other hand, has been working with Europe: Trying to convince Germany to give the leash a little slack. ”Spain to Get Room on Deficit Rules” details how Spain will have a little more time to reduce its budget deficit:

http://online.wsj.com/article/SB10001424052702304543904577394381158093936.html

Finally, "Euro in the Eye of Continental Storm,” provides reasons why the euro has held up well despite all the turmoil:

http://online.wsj.com/article/SB10001424052702304543904577394491110287180.html?mod=ITP_moneyandinvesting_0

But let's not forget that there are voters in Germany as well as Greece and Spain. German citizens are tired of giving, and Chancellor Angela Merkel must give credence to their views if her government is to survive. So there is a tug-of-war going on among Europe's citizens, not just its governments and their leaders. Germans demand austerity because they are tired of paying, while Greeks and Spaniards insist that they need more assistance because they can't live with continued austerity.

These are huge challenges for Europe's leaders and Europe's citizens. Since they have met such challenges before, there is optimism they will meet them again.

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann

New-Vehicle Sales Strong

The Lehmann Letter (SM)

The stock market is down this morning because eyes are on Europe and its debt crisis: How will the European nations pay their debts? What do the recent elections mean? What will happen to Greece? Will Europe survive austerity? How will Europe deal with weak economic growth? Will the euro survive? These are legitimate questions that require answers.

This letter remains optimistic, but many events have yet to unfold.

Meanwhile, except for housing, there is strength in the American economy. Recently the Department of Commerce announced 14.4 million new-vehicle sales in April at a seasonally-adjusted annual rate.

This year has been running strong, with monthly auto sales over 14 million. The chart reveals good progress from recession's depths when sales fell below 10 million.

New-Vehicle Sales

(Click on chart to enlarge)

(Recessions shaded)

But the key question remains: Without a robust housing recovery can auto sales break through 15 million and recover the 16 - 17 million pace they enjoyed before the recession?

Vehicle sales are linked to housing sales because housing is our barometer on the strength of consumer balance sheets. Housing can't recover until consumers, and the banks that lend to them, have regained confidence in household balance sheets: That net worth is adequate, debt is manageable and liquidity sufficient. When that occurs household exuberance will spill over into new-vehicle sales and restore autos' past strength. And strength in housing and autos would return the economy to full employment.

Housing is key.

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann

Household Debt Pops Up

The Lehmann Letter (SM)

  

Yesterday the Federal Reserve released a very encouraging report on consumer borrowing:

http://www.federalreserve.gov/releases/g19/current/default.htm

Consumer credit grew by $255.6 billion in March at a seasonally adjusted annual rate. Take a look at the chart: This is far above the typical increase of approximately $100 billion. You will also notice considerable noise in the data. The numbers fluctuate sharply from month to month. But this is a good, strong report that should encourage optimism about consumer spending.

Consumer Credit

(Click on chart to enlarge)

(Recessions shaded)

Tomorrow's letter will look at new-vehicle sales. They rely heavily on consumer credit for their financing.

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann

European Elections and the Euro

The Lehmann Letter (SM)

  

France and Greece voted out their governments because of disillusionment with austerity and their weak economies. This disillusionment is also apparent in Spain, Italy and other nations on Europe's fringe that are struggling with high debt and high unemployment. Mighty Germany, with relatively low unemployment and low debt, wanted them to abide by the rules of the game: Higher taxes, lower spending and contracting economies. They rebelled.

Now Europe must re-examine how it will deal with weaker nations' government debt. New French and Greek governments will turn away from austerity while Germany will continue to advocate for austerity. Thus far, however, the newly elected are not advocating the abandonment of the euro. The European project - an ever more integrated continent - remains intact.

We will see whether or not the continued drive toward European integration - Europe's goal since the end of World War II - will survive this latest upheaval. The European project has survived past challenges: Compromise has prevailed. This letter believes compromise will prevail once more and the euro will survive.

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann

115,000

The Lehmann Letter (SM)

This morning the Bureau of Labor Statistics (BLS) reported that the economy added 115,000 jobs in April:

http://stats.bls.gov/news.release/empsit.nr0.htm

Last month BLS reported a gain of 120,000. That has now been revised upward to 154,000.

This is not good enough to restore full employment.

Job Growth 

(Click on chart to enlarge)

(Recessions shaded)

You can see from the chart that a strong economy provides monthly gains of 250,000. We had that in February, and need to get back on track.

Unfortunately government has been shedding jobs, so that private-sector gains are somewhat offset by government losses. (In April the private sector added 130,000 jobs while government employment fell by 15,000.) That’s too bad because government employment is within the reach of policy control. But fiscal stringency has forced government cutbacks.

So the private sector must work that much harder. Our eyes turn once again to housing, the big laggard. We’ll see what this month has in store.

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann

Profit Margins Stall

The Lehmann Letter (SM)

The Bureau of Labor Statistics announced this morning that labor productivity had fallen by 0.5% in the first quarter because hours worked had increased more than output.

http://stats.bls.gov/news.release/prod2.nr0.htm

This is understandable at this stage of the economic expansion: Employers typically have resumed hiring and there is the risk that they will add labor more rapidly than output grows.

If you dig deeper into the report you will also discover evidence that the growth in profit margins has stalled.

Profit Margins 

(Click on chart to enlarge)

(Recessions shaded)

The chart vividly portrays profit margins' long-term growth since 1990. After a setback at the end of the dot-com boom in the late 1990s, profit margins have expanded especially rapidly since 2000. Now they are at an all-time high.

Can we expect them to grow to the sky like Jack's beanstalk? No, we can't. For a decade, from 2000 to 2010, employers boosted output more rapidly than they hired labor. This was especially true during and in the aftermath of the recent recession. Businesses had reduced employment by more than output had fallen. Output per hour grew, swelling profit margins. Today profit margins stand at the record levels mentioned above.

Meanwhile total corporate earnings (the product of profit margins multiplied by sales volume) more than doubled since 2000 and have recovered all of their recession losses. This was largely due to the sharp jump in profit margins analyzed in the paragraph above. If the growth in profit margins has now stalled, growing sales volume must drive all future gains in total earnings. That is not likely to occur as the economy recovers slowly.

We should therefore expect a slowdown in earnings growth. That doesn't augur well for the stock market.

(Correction: Yesterday's post mistakenly referred to "unemployment" when it should have referred to "employment." That error has been corrected.)

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann