Initial Claims Forecast

Last week's initial claims number 0f 474,000 suprised both me and the consensus. This week, I predict 464,000, once again in line with the consensus estimate of 465,000.

Initial Jobless Claims Forecast

My model forecasts initial claims to decline to 451,000 this week, in line with consensus of 455,000.

I didn't post last week, which is a shame, given the results. For the record, my model predicted 462,000, well below consenus of 480,000 and in line with the actual result of 457,000.

Initial Claims Forecast

My forecast for initial claims of unemployment insurance for this week is 491,000, compared with a Bloomberg consensus forecast of 500,000.

Predicting Initial Claims

This week I've been looking at how well the consensus forecast of Wall Street analysts predicts various economic data just before the data are released. Mostly, the consensus is pretty good, but for initial jobless claims, it's bad. In fact the correlation of the consensus forecast of changes in the initial claims number with the BLS data is just 47%. Here is the chart:

So I wondered if I could do better. Turns out I can, I just had to get a little creative. My model manages to get the correlation up to 72% and the R^2 to 0.52. Here's the scatter plot:




I'm not going to tell you how I do it, but as a public service I will post my estimate of the weekly claims data every week in this space. Unless, of course, it interferes with our trading, and then I'll stop.

A Bit of Perspective

Given the economic environment, it's pretty easy these days to feel like life is treating you unfairly. In fact, recession or not, all of us find ourselves on the unhappy side of Lady Luck's favor every once in a while, and we often feel angry or cheated. But, from time to time, you have an experience that makes you realized just how lucky you really are. I just had one of these, so let me tell you about it.

A mild-mannered young gentleman just left my house; he was here installing my internet. He had a 786 cell phone number (Miami), and a thick latin accent. So I thought: maybe he's from Cuba? Turns out he is, and after a bit I ask him if he is an interesting story of how he got here. Well.

"Yes," he says. "18 days at sea."

"18 days?"

"We go by boat. We buy the boat from a man, but he charge us very big price, but he tell us we have to pay before. We go to the address where the boat is, and the boat is fourteen feet, for nine people, and the motor has no oil."

The route, apparently, is to go to the Caymans and get some provisions, and from there to Honduras. The trip is supposed to take only a few hours, so they thought. But, soon after leaving the Caymans, the motor (with no oil) dies, and there is no choice but to throw it overboard. They use their clothes to make a sail, but "nobody know how to do it," so "where the wind go, phhht, we go!"

After 11 days or so, they run out of food, and the last week it is no food, only two cups of water a day, one in the morning and one in the afternoon. Once, sharks circle the boat for several hours. (Apparently, it is not uncommon for asylum seekers to be scared by this and choose to throw someone to sharks in the belief that the sharks will attack the boat if not. Fortunately that did not happen in this case.)

Finally, on the 17th day, they can see the Honduran coastline in the distance. But there is no wind, and they have not moved in 14 hours, according to their GPS. Running out of water, it is now or never. They break apart their water tank into 4 pieces, and use the pieces to row, from 10PM to 4PM the next day, to the coast.

From there, it is up the peninsula to the United States. On the way, they are intercepted by the Mexican authorities, where he spends a month in a Mexican prison. If you are Cuban, they were supposed to give you asylum, but it takes a while sometimes, and in the meantime, you are stuck, "with real criminals," he says. "Mexico is so corrupt. If you have any money, they take it all."

"So then what?" I ask. "Through the desert?"

"Oh, then you just cross the border," he says, like it's nothing.

And that is how the polite gentleman from Cuba came to be installing my internet connection.

Just What Are We Buying, Anyway?

So, everybody knows are Americans are incorrigible consumers, who recklessly tap their houses for more and more cash and run up catastrophic credit card bills in order to buy plasma TVs. Right? Well, maybe not.

The first chart, from Calculated Risk, shows personal consumption expenditure (PCE) ex-health and health care spending as a percentage of GDP. Non-health expenditures have basically been constant between 56% and 59% of GDP since 1960, and has changed very little in the last decade.

The second chart shows health care spending, personal saving, and their sum since 1946. That sum has also been relatively constant since 1970. So, we weren't really using our home ATMs to pay for plasma screen TVs, we were using them to pay for hip replacements and chemotherapy.

Does it matter? I think that depends what the question is...

Disintermediation at Its Finest

From today's FT, bond issuance is skyrocketing while syndicated bank loans are still plummetting. This is "disintermediation" - banks won't lend because they don't have the equity and are delevering, while consumers are trying to save. The solution is the bond market. Yesterday's Treasury data showed that long-term US risk assets, at least, are being purchased by Americans. Foreigners are purchasing Treasuries. Here's the FT:

Corporate bond issuance has risen to $1,103bn so far this year, beating the annual record of $898bn in 2007, according to Dealogic, the data provider. The jump in issuance has been seen in dollar, euro, yen and sterling-denominated deals.

Volumes in dollar, euro and sterling have risen to record annual highs, only eight months into the year, while volumes in yen are close to record levels. Dollar issuance has risen to $487bn, euro issuance to $299bn, yen issuance to $64bn and sterling issuance to $53bn.

In contrast, volumes of syndicated bank loans this year are 52 per cent down on 2008 and 69 per cent down on 2007, as banks are more reluctant to lend
as they repair their balance sheets.

So far this year, syndicated bank lending has risen to $1,052bn compared with $2,182bn over the same period in 2008 and $3,369bn over the same period in
2007.

So in total, we lost $2.2 trillion in syndicated bank loans and gained $8-900 billion in bond issuance (annualized). If this is cause to break out the champagne, better stick to the Andre.

What's the Fed Been Up to?

The Fed's balance sheet is in a constant state of flux these days. There have been two key changes since the peak of excess reserves in mid-May. Below is the Fed's most recent balance sheet, as well as the balance sheet for May 20.

First, the Fed has been withdrawing term auction credit, which the banks were putting back on deposit with the Fed as excess reserves. That change is in red. It has no effect on the money supply or the real economy.

Second, they've reduced the sizes of swap lines with foreign central banks and instead have bought securities outright. They've also shifted some of their operations to buying securities outright. These changes are in green. Overall, the money supply is unchanged, but the policy is quite expansionary. That's because the swap lines are used to take foreign securities out of the market (they are pledged to foreign central banks by foreign banks in exchange for dollar funding), while the securities the Fed is buying instead are US Government and Agency securities. So even though the total monetary base hasn't changed much, this still represents a significant credit expansion.

The Circularity of Mark to Market Accounting

The present crisis has seen a lot of debate about mark-to-market accounting. Traders tend to favor mark-to-market, as do academics who mistrust banks' motives and accounting. Bankers and efficient market skeptics argue for more flexibility. The usual problem, of course, is that in a crisis prices can plummet for liquidity reasons, which can cause institutions to become insolvent on a mark-to-market basis, causing bankruptcies, liquidations, further price declines, and more insolvencies. Very few people are comfortable actually allowing this dynamic to play out, but it is a struggle to find a credible alternative accounting regime. For large institutions, like the banks that hold troubled mortgages, there's an even more fundamental problem with mark-t0-market accounting: it is circular and therefore not well-defined.

Mark-to-market accounting says that assets should be valued at their market prices. The market price for an asset depends on the large institution's demand for the asset -- that is well-known. But the large institution's demand depends on the market price, and if the institution is levered, its demand may in fact depend positively on the price of the asset.

So the question is: when the bank is valuing its assets, should it consider the market price including its own demand, or not including its own demand?

The problem is even more acute when there are speculators driving down the price of an asset solely because they anticipate that they will force a large, levered investor to liquidate. In other words, the market price may only be low because investors believe liquidations are coming, and those liquidations are only forced by the investors' belief. It becomes an extremely destructive self-fulfilling prophecy.

What's the right solution here?

Negative Interest Rates Again

A few months ago I commented that zero wasn't really the lower bound on interest rates, it was probably slightly below that. Well, the Swedish Riksbank today cut its deposit rate to negative 0.25%, meaning that banks will have to pay to hold excess reserves. Did the kroner collapse? Is there a run on the banking system? No and no. Why? Because holding large quantities of cash is, quite simply, a tremendous bitch.

Unemployment Fake-Out

At first blush, it appears as though we got some good news today, with continuing unemployment claims having fallen by 148,000. I don't think this is indicative of people getting jobs, I'm sorry to say. Unemployment runs out after 9 months (Congress extended the period because of the recession), so in June their unemployment benefits run out. Hence, the reduction in continuing claims. Ouch.

Dollar? I barely even know 'er!

The US fiscal situation and the Fed's expansion of the money supply have spurred some here on Wall Street to question the dollar's status as a reserve currency.

Rodin thinks that's overblown to say the least -- to paraphrase Winston Churchill, the dollar may be the least secure currency out there, except for all the other ones. Are you going to trust the Euro, whose value is not even backed by a national government? Or the yuan, which even if you could freely trade it would still be the currency of a country that has had two revolutions in the last century, deep social fissures, and a government without legitimacy? No, there's no other currency in the world that even comes close to meeting the requirements for a global reserve currency.

I put a little more stock (though still not much) in the theory that wealth will be held in commodities, which in the case of central banks means precious metals and gems. Remember that if you don't have access to a whole lot of storage space, you can't actually buy most commodities, you can only buy the right to receive them. That right has credit risk attached.

One Equation, Two Unknowns

Check out Asian deflation -- it is the alternative to a rising dollar in the presence of managed exchange rates. Note that while we'd usually expect deflation abroad to lead to dollar weakness, this deflation is actually the result of a sharp drop-off in demand for East Asian exports that also exerts downward pressure on those currencies. We are getting deflation instead of currency depreciation because exchange rates are managed. Possibly soon we will get both.

Presented Without Comment

In 2007, 12% of new auto sales nationwide were financed by home equity loans. In California, it was 30%.

To Formalize, or Not to Formalize

The holy grail of the economics profession is to be able to write down a closed-form, quantitative, formal model that accurately and precisely explains the evolution of the economy. Even though pretty much everyone recognizes that this is pie-in-the-sky, there remains a bias towards models in which all behavior is explained within the context of the formal model, where only the institutions are exogenous. The result is a divide in the profession between economic historians and a minority of straight economists on the one hand, and the mainstream of the profession on the other hand.

The historians and the minority tend to make narrative and "story" arguments about the evolution of the economy, relying heavily on historical facts and circumstances. They allow for complex patterns of behavior and expectations and naturally incorporate policy changes. While they sometimes make allusion to formal models, they rarely spend much time developing them. They can therefore capture broad trends relatively well, but have some difficulty with detailed forecasts.

The mainstream position, by contrast, develops detailed models that tend to incorporate with certainty (which I take to include stochastic rules) the evolution of behavior and expectations. The resulting models can therefore make detailed and precise quantitative predictions, but the simplistic behavioral rules required to make the models tractable cannot capture economically important behavioral and expectational complexities, stories and paradigms.

The solution, I think, is to recognize that expectations, behavior and policy are difficult to model quanitatively but nonetheless respond to economic as well as social variables. That calls for marrying quantitative formal models with the economic history approach: a good economic explanation should include both a formal model that takes these "soft" variables as exogenous and a narrative that explains how these exogenous variables may evolve with the economy. The narrative and formal model can then feed back on each other with the economist as a guide. To put it another way, the narrative informs structural changes in the formal model, and the results of the formal model feed into the narrative.

Production Decisions in the Real World

This is one of the very best economics articles I've seen in a long time. It traces the impact of demand shocks through the global supply chain and shows how the division of labor has created deep information problems that compound uncertainty and fluctuations. It is just crying out for a model based on those phenomena. To me anyway, it suggests that economic fluctuations are likely to be chaotic.

I Love Europeans...

...and the beautiful understated way they have of putting things.

Exhibit A:

"With regards to Europe, because of the methodology, in our view we do not have an entirely convincing analysis," ECB President Jean-Claude Trichet has said.

Translation to Washington-speak: "The analysis is seriously flawed and does not take into consideration many important factors."

Translation to Wall Street-speak: "You're an idiot and your analysis is f***ing garbage."

Negative House Prices

There's been a spate of stories recently that ostensibly demonstrate that in selected markets, house prices are negative; in some cases significantly negative. That challenges an important assumption in many economic models -- what we economists call "free disposal" and "non-satiation."

A rather graphic demonstration comes from Calculated Risk: http://www.calculatedriskblog.com/2009/04/new-homes-demolished-in-victorville-ca.html

Today's WSJ printed this piece about a California town threatening bank executives with arrest if they don't maintain foreclosed homes.

There was another piece a while back, before I started the blog, describing how banks in Indiana are actually walking away from foreclosures because it would cost them more to maintain the house than they would net from a foreclosure.

See this excerpt:

Mercy James thought she had lost her rental property here to foreclosure. A date for a sheriff’s sale had been set, and notices about the foreclosure process were piling up in her mailbox.

Ms. James had the tenants move out, and soon her white house at the corner of Thomas and Maple Streets fell into the hands of looters and vandals, and then, into disrepair. Dejected and broke, Ms. James said she salvaged but a lesson from her loss.

So imagine her surprise when the City of South Bend contacted her recently, demanding that she resume maintenance on the property. The sheriff’s sale had been canceled at the last minute, leaving the property title — and a world of trouble — in her name.

“I thought, ‘What kind of game is this?’ ” Ms. James, 41, said while picking at trash at the house, now so worthless the city plans to demolish it — another bill for which she will be liable.

City officials and housing advocates here and in cities as varied as Buffalo, Kansas City, Mo., and Jacksonville, Fla., say they are seeing an unsettling development: Banks are quietly declining to take possession of properties at the end of the foreclosure process, most often because the cost of the ordeal — from legal fees to
maintenance — exceeds the diminishing value of the real estate...

Ouch.

Is China a Bubble?

We've been hearing for several years now about China's massive growth and off-the-charts savings rates. But I've seen a few things recently that have made me start to question these.

First, I heard an economics nobel laureate say that China's household savings rate is not very different from the rest of Asia; their high national savings rate is largely accounted for by corporate savings, namely retained earnings. Now, retained earnings are profits that are not paid out as dividends, or more precisely, reported profits that are not paid out as dividends. What if those reported profits aren't quite on the up and up?

Second, China's banking system has been pretty weak for a while. It's riddled with non-performing loans that do not get written off. So who knows about the real state of the system?

And then third, the Wall Street Journal today published this article, which details the massive debt crunch that is facing Chinese universities. One excerpt:

China is suffering from a higher-education equivalent of the global credit bubble. On government orders, China's universities -- most of which are state-controlled -- boosted enrollment by up to 30% a year, year after year for most of this decade, and built vast new campuses. Financing was considered a cinch: New students would mean more tuition to pay off the loans that funded the expansion. But those plans were wildly optimistic, leaving hundreds of universities across China crippled by debt...

In impoverished Anhui province, 50 universities owe $1.2 billion to banks, according to Zhao Han, who is vice president of the Hefei University of Technology in Anhui. Mr. Zhao, who is a government adviser with access to the financial figures, says some schools have debt payments that equal half of their tuition revenues.

This is classic, CLASSIC bubble stuff.

It's a far cry from three snippets to calling a bubble, but this is something I'll look into for future posts.

Tin Cans...

...are 10-20% of the materials cost of canned food, according to the Wall Street Journal. And that's not even real tin, just tin plated! Which begs the question: tin-plated WHAT?

Econ 101, Revisited

I've always been slightly bothered by the old Econ 101 equation:

(1) Y = C + I + G + X - M

and its counterpart:

(2) 0 = (I - S) + (G - T) + (X - M)

The thing that's gnawed at me is how exactly it is that savings (a decision not to spend) gets magically channeled into investment (e.g., an active decision to build a factory). Part of the answer is that if I save and don't spend, someone else must have dis-saved. But what if I chop down a tree for some firewood, sell the firewood, and save the money? I saved, but the person who bought the firewood and put it in his garage didn't dis-save! It's hard to call that investment.

Savings are really a claim on future consumption, and you can have this in three ways:

1. Ownership of the actual means of production. That corresponds to investment.
2. Ownership of the goods you want to consume. That's inventory accumulation.
3. Cash dollars. These are the portion of future production against which there are explicit claims. The government can create these dollars, which are not really liabilities of the government per se but rather of the society as a whole -- it is everyone in the society that must redeem the dollars, not just the government. Cash dollars are like goodwill in accounting -- they are a recognition today of value that will be created in the future.
   

All this points to a slight revision of the above. Equation (1) needs to have inventory accumulation (call it N) added to it. And equation (2) needs to be adjusted for cases when the government prints additional money (call monetary growth J).

So we have

(1*) Y = C + I + G + X - M + N

and

(3) G - T = J - SG

where SG is government savings, or more precisely change in publicly held government debt. The new equation (2), adjusted for money growth and inventories, then becomes:

(2*) 0 = (I + N - S) + (J - SG) + (X - M)

Personally, I find this formulation more satisfying, because there's no "magic" about how savings gets transformed into investment; inventories and money provide some wiggle room.

There's much more to be said here about the implications of expanding the money supply. But that is material for another post.

The Fed Marks to Market

Nice post from Zero Hedge suggesting write-downs to come.

http://zerohedge.blogspot.com/2009/04/fed-reports-over-30-loss-on-bear.html

This chart is from the IMF Global Stability Report -- it shows European banks are continuing to create securitized assets, even though they can't sell them, because they are eligible collateral at central banks. Should we be afraid, or are these high-quality assets written with good underwriting standards, given the tight credit environment?