America Fighting Economic War on Four Fronts

Economic growth in America has been sluggish since the end of the recession in 2009. There are myriad reasons why this is happening. Many of them are internal to our country, such as government uncertainty related to health care and bank regulation.

But internal problems are being compounded by warlike conditions that are hindering our economic recovery. In my opinion, the U.S. economy is being assaulted in four different “wars.”

First, is the actual war, our military involvement in the Middle East. This fighting requires an expenditure of resources that could be used to invest in America’s future by building roads, bridges and other infrastructure that would enhance our long-run competitiveness in the global economy.

The second front is the cyber war. Every day somebody from Russia, Eastern Europe or China steals credit card information, health records, business secrets and our newest technology. Our banks and businesses have to spend massive amounts of time and money to defend against these assaults.

The third front is the currency war. In the global currency arena, whoever has the cheapest currency has the best advantage to sell products around the world. Japan and China are experts in this tactic. They know that if they keep their currency and products cheap, Americans will prefer to buy their products over more expensive products made here. Europe is now doing the same thing. They talk incessantly of the need for printing more money. Talk like this makes the Euro cheaper. It gives Germany and others an even greater advantage when they sell cars and other products in our country. As these countries succeed in the currency war, it will be harder for American workers to compete.

The fourth front is in the energy market. Can you remember back in the golden days when filling stations would have a “gas war”? One station would arbitrarily cut the price of gasoline to get all of the sales that day. For historical reference, this would have been back in the days when Herman’s Hermits and the Dave Clark Five were the hottest new bands. Well, Saudi Arabia and OPEC have declared a gasoline war on America. They are determined to produce enough oil to make the price go way low. If they can get the price low enough, they think they can greatly reduce American oil and gas production (meaning massive layoffs in the U.S. energy sector).

So, when you look at the entire global perspective, the U.S. economy is doing pretty well. It continues its modest growth while simultaneously fighting global wars on four different fronts, but the United States is still the strongest economy on earth.

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Why Hasn’t Full-time Employment Recovered?

Since the end of the Great Recession in June 2009, the number of full-time employed in the United States is 2.2 million below its 2007 pre-recession peak (Figure 1). Although, the number of individuals working part time has remained high, it’s starting to decline (Figure 2). Part-time work increased during the recession, which is typical. The increase was high, which is not surprising given the magnitude of the recession. However, the persistence of part-time work levels in the ongoing recovery and expansion is unusual because it’s accompanied by a slow recovery in the number of full-time workers.

Why do people work part time? The Bureau of Labor Statistics (BLS) differentiates between economic and noneconomic reasons. One economic reason is that workers who prefer full-time work are typically regarded as involuntary. They are working part time because in slack times businesses cut back employee hours. Sometimes workers can’t find full-time work.

Noneconomic reasons involve voluntary part-time workers who work part time because of medical needs, child-care issues, other family or personal obligations, school or retirement.

Most part-time work is for noneconomic reasons. Part-time work for economic reasons rises in recessions and falls in recoveries (Figure 3). This is an example of what economists call “cyclical” unemployment. The increase during the Great Recession was especially large, and there is still a high prevalence of involuntary part-time employment.

When people who want to work lack the skills employers are demanding, economists call it “structural” unemployment. Analysis of part-time work for economic reasons shows that part-time work levels are due to business slack that is still above pre-recession levels and continuing to fall (Figure 4). The continued high incidence of individuals working part-time for economic reasons can be traced to the slow recovery of jobs lost during the Great Recession rather than a permanent shift toward part-time jobs. There have been alternative explanations of the persistent high level of involuntary part-time work. These include:

  • limited education of some prime-age workers age 25 to 54 (Figure 5) and
  • the 30-hour cutoff for employee health benefits under the Affordable Care Act (ACA).

The first explanation is a structural issue. It relates to the skills and education of the workforce. The United States faces some daunting educational challenges to prepare people to work in a globalized economy. Effective solutions for structural employment begin with improved education, which tends to be expensive and take a long time to pay off. To achieve full employment, skill mismatches between workers and employers must be resolved. Otherwise, the economy could grow, but there wouldn’t be enough qualified workers to fill the vacancies.

The second explanation reflects employers’ incentive for creating part-time jobs to avoid paying health benefit costs. Part-time employees usually work less than 35 hours weekly. Recent research suggests the ultimate increase in the incidence of part-time work in response to the ACA provisions is likely to be temporary and small. In Hawaii, for example, part-time work increased only slightly in the 20 years following enforcement of a state employer health-care mandate. Also, as occurred after Massachusetts’ implementation of a similar law, the increased cost may cause firms to shift compensation from wages to health care.

Many articles and blogs have taken issue with the type of employment growth in the current economic recovery and expansion. Interestingly, the complainants maintain that part-time jobs displace full-time positions and cause a fundamental change in the labor market. Such complaints have existed since the 1991 recession.

The lack of new full-time jobs has contributed to the modest recovery in the U.S. economy, including the housing market. Whether a prospective homebuyer works fulltime or part time is key when deciding to purchase a home. It also affects consumption behavior and the demand for goods and services because part-time positions include fewer benefits.

Going forward, involuntary part-time work should be monitored to asses if working part time for economic reasons reflects the slow recovery in full-time employment rather than permanent changes in the proportion of part-time jobs.

employed full-time

employed part-time

part-time by reason

part-time by economic reasons

full-time education

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Trends in Farmland Properties

This is the third of a three-part series on real estate trends. This post focuses on farmland and highlights some things I heard at the annual convention of the American Society of Farm Managers and Rural Appraisers.

Farmland trends

  • Agriculture is a $3 trillion industry in the United States, and $2.4 trillion of that is in real estate.
  • Crop-producing farmland has posted tremendous capital gains in the past eight years.
  • Prices have risen to record levels, and investor returns are at historic low levels.
  • The low debt-to-asset ratio of just 11 percent means that any decline in farmland prices is unlikely to cause a banking crisis like the 1980s.
  • Large pension funds are interested in investing in farmland, and their interest is growing.
  • Ag land prices are not highly correlated with stocks or bonds. They allow investors to get some protection from big swings in stock and bond prices. Farmland is correlated with commodity prices, gold and the Consumer Price Index.
  • These pension funds are expanding their investment horizon into land that produces fruit and nuts.
  • Net income to farmers is expected to be lower in 2014 when compared with the past two years. But income is still high relative to long-run income trends.

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Homebuyer Help in 2015 and Other Trends

This is the second of three posts regarding trends in real estate markets. The first was on commercial markets. Next time I will discuss trends in the farmland market. Observations in this post were gleaned from my participation in the 2014 convention of the National Association of Realtors.

Here are some of the trends Realtors were discussing.

  • The average age of homebuyers in 2014 rose to 44, up from 39 years in 2010.
  • First-time buyers made up just 33 percent of the market in 2014, down from the long-run average of 40 percent.
  • There was a marked drop in single female buyers in 2014.
  • Americans are living in their homes much longer than in the past. The current tenure of homebuyers is ten years, up dramatically from six years in more normal times.
  • Homebuyers are still finding it difficult to find a property they like.
  • Finding a property is even harder than getting a mortgage.
  • Several factors are constraining home sales volume in 2014.
    • Many Americans don’t have the 20 percent down payment.
    • A segment of Americans have tarnished credit in the aftermath of the Great Recession.
    • There are a limited number of homes to choose from in many markets.
    • Mortgage lenders are still reluctant to make loans to potential buyers with lower FICO scores.
  • Help is on the way in 2015 for American homebuyers. It appears that Fannie Mae and Freddie Mac will be more amenable to making mortgage loans with just a 3 to 5 percent down payment for borrowers who can demonstrate the ability to make the payments.

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Commercial Real Estate Trends

In recent weeks, I have participated in national conventions for the CCIM Institute, the National Association of Realtors and the American Society of Farm Managers and Rural Appraisers. I have had numerous conversations about commercial, residential and farmland property trends. This is the first of three posts with my takeaways from these meetings.

Commercial Markets

  • Foreign investors from all over the world are still piling into U.S. real estate properties.
  • There is intense demand from foreign investors to use “EB-5 funds”* to purchase real estate.
  • There is some concern among lobbyists that the 1031 exchange may be under fire in the next Congress.
  • One broker told me she had sold two apartment complexes (one in Beverly Hills and the other in San Francisco) for a cap rate below 3 percent. The lowest cap rate I had ever heard of before that was 3.5 percent for apartments back in 2007.
  • There is still intense institutional competition for quality office and multifamily space in the dense urban areas of our biggest metros.
  • There’s little interest yet in suburban office and flex industrial space.
  • While construction has increased, absorption is still exceeding completions in most markets.
  • Amazon’s new business model is creating demand for warehouse space in many parts of the country.
  • Demand for manufacturing space has been muted as companies continue to automate their processes.
  • Mortgage money for commercial properties is getting cheaper and easier to come by as lenders get more aggressive to make deals happen.

*Congress created the fifth employment-based preference (EB-5) immigrant visa category in 1990 for qualified foreigners seeking to invest in a business that will benefit the U.S. economy and create or save at least ten full-time jobs.

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Policy Planning for the Next Financial Crisis

Dramatic growth in household debt preceded both the Great Depression and the Great Recession. Both episodes also were characterized by large, persistent declines in consumption. During the crises, highly leveraged households aggressively sought to reduce their debt burdens by postponing consumption. This was especially true of those that experienced large house price declines.

Highly leveraged household balance sheets are essential drivers of deep and prolonged economic slumps as households focus on lowering debt instead of buying goods and services that stimulate economic growth. In addition, indebted households were often unable to refinance their mortgage rates into historically low interest rates as home equity credit availability declined considerably after the crisis. This deleveraging of households has served as a drag in the rate of growth during a recovery and expansion phase.

So what should be the correct policy if another housing market crisis occurs? Should the highest priority be helping cash-short homeowners maintain spending in a weak economy and helping them avoid foreclosure by temporarily reducing or deferring mortgage payments?

Getting homeowners back to participating in the economy has focused primarily on two possible policy solutions: principal write-down and temporarily reducing monthly payments by deferring mortgage payments, reducing interest rates or extending the mortgages’ term. A principal write-down is when a policy is implemented to lower the borrowers’ loan principal during a housing crisis.

For example, you may owe $250,000 on your home, but your principal is reduced to $225,000. This not only affects how much you have in your pocket to spend today, but also offers stimulus for the entire remaining period of the debt. Overall, reducing the total amount owed could help reduce the number of underwater homeowners and strategic defaults, but it does not help the liquidity issues of cash-short homeowners trying to maintain their consumption patterns. It also may offer an incentive for moral hazard by highly leveraged homeowners who might expect to be bailed out in the future.

The second option for putting money in homeowners’ pockets today is reducing interest rates for short periods or maybe extending the duration of the loan so monthly payments are lower and homeowners meet their payments and have enough left to continue to spend and support the economy. One way of planning for this in the future is to redesign mortgages to allow contracts for lower monthly payments when both borrowing constraints exist and home prices fall. Lenders could play an important role in this process because they benefit from reduced mortgage defaults. This type of mortgage could have a clause to automatically refinance into a lower-adjustable rate even if a homeowner is underwater, thus allowing the homeowners to reduce spending to meet their mortgage payments and preventing them from defaulting. This would be contrary to what was observed during the recent crisis, when many illiquid homeowners were locked into high-interest mortgages, were underwater and unable to access refinancing at a lower rate. While packaging this type of mortgage would not be simple, it still has possibilities.

For example, let’s say you have a $200,000 fixed-rate mortgage at 6 percent for 30 years, with 12 monthly payments. Over the course of the loan, you would make 360 (30 x 12) payments. The monthly fixed-rate mortgage rate would be .06/12 = 0.005. Thus, the monthly payments would be approximately 200,000 x [0.005 x (1+0.005)^360]/[((1+0.005)^360)-1]= $1,199.10. Refinancing the $200,000 mortgage from 6 percent to 4 percent reduces monthly payments from $1,199.10 to $954.83 or a 20.37 percent reduction. The identical reduction in monthly mortgage payments would be reduced if the principal amount of the mortgage loan was written down from $200,000 to $159,258, also 20.37 percent.

Of course the best solution to any crisis is preventing one. The focus should always be the prevention of future housing crises from occurring ever again. Unfortunately, financial crises have occurred throughout history and will occur in the future. It is prudent to know the best policies to implement during any crisis to return the economy back to its long-run growth trend.

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Why Raising the Minimum Wage is a Bad Idea

Wouldn’t it be great if you could just tell every business owner to raise the wages of their employees? Then everyone would be happier and better off. Right?

The mantra I’ve heard is that “increasing the minimum wage lifts people out of poverty.”

This statement is partially true. If you have 100 workers making $8 per hour and you raise the minimum wage to $16, some of these workers are lifted out of poverty. Maybe 50 of the workers are now making twice as much money, but what about the other 50 workers that were fired because the company couldn’t afford the wages?

Here is real life. Business owners are trying to keep their businesses alive in an extremely competitive environment. Every year their costs increase. Things like property taxes, electricity, health care and other costs to satisfy heavy government regulation.

What happens when wages increase substantially? The business owner has two choices: fire a bunch of workers or replace them with machines.

It’s no wonder that young people are having a hard time finding jobs. Back in the day, you could work at the grocery store as a cashier or sacker. Oops, there are machines doing a lot of that work now. Or a young person could have a paper route to earn money. But nobody is reading newspapers anymore. Many young people served as tellers at banks, but the ATM is replacing lots of them. In fact, Internet banking is replacing the entire bank.

Several months ago I mentioned that if you raise the minimum wage too high, business owners will just replace the workers with machines. Here are some more recent headlines.

Applebee’s plans to install a tablet at every table in its 1,860 restaurants in America. Chili’s is doing something similar.

Lowe’s has just announced it is going to experiment with a robot greeter at its stores.

Where will everyone work when the machines have been fully deployed?

Keep your eyes open for this growing trend. As the minimum wage increases, retailers that already pay high property taxes and utility costs will continue to find ways to replace people with machines.

Soon, the stores and cafes will be empty of people. Just walk in and push the buttons to order. Go up to the counter, say “hi” to the cook and get your food. The cook may want to chat a moment because he will be lonely working by himself. Eat your food while you play video games on the tablet. Then swipe your card and leave. Maybe you tip the cook a dollar just for old times because he was the only human voice you heard.

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Stop the Presses. There’s Good News Out of Washington

In my June 19 blog post, I mentioned that Fannie Mae and Freddie Mac had a new overseer (conservator), and he was talking about making it easier for Americans to buy a home. After years of super-conservative mortgage lending, Mel Watt told the world he was going to try to help more people buy a home in the United States.

I’m always skeptical about statements that come out of Washington, D.C. I learned a long time ago that just because someone in D.C. says something, it doesn’t mean that anything will come of it. But at the same time, I still remain naively hopeful that occasionally someone in Washington will actually do what they promise.

It appears that Mr. Watt might be just such a person.

In an Oct. 17 article, the Wall Street Journal reported that Fannie and Freddie and their regulators were close to an agreement to “greatly expand” mortgage credit and give some much needed protection to mortgage lenders.

The article reported it would be easier for lenders to offer mortgages with just a 3 percent down payment again. The new policies will be designed to ease lender fears of regulatory and legal punishment if they make a home loan that subsequently becomes delinquent.

This is a big deal.

The housing market is a vital component of the U.S. economy. We need to sell more homes, and we need to build more homes. Part of the reason new and existing home sales haven’t grown in 2014 as fast as expected is that it’s still too hard for qualified buyers to get a loan. Many people in the United States simply don’t have the funds for a 20 percent down payment.

If these changes are made, then it will open up the home purchase option to many Americans who currently can’t get a mortgage. Existing home sales will increase. New home sales will increase. New home construction will increase and create lots of new jobs.

Our economy could use a shot in the arm. A more robust housing market is about the most potent shot it could get.

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Don’t Expect Inflation Anytime Soon

It’s no secret that most of the things we buy today are made by Chinese workers. We buy other things from European and Japanese workers, and we buy oil from the Middle East.

When the U.S. dollar gets stronger compared with the currencies in these countries, it buys a lot more stuff. That’s exactly what is happening now. Our dollar is getting more valuable, compared with the Euro, the yen and the yuan.

Here is “takeaway” theorem number one:

A stronger dollar is deflationary to the U.S. economy.

One reason for this is that our economy is stronger than most others’. It’s not very strong, but compared with most, we look like The Incredible Hulk. We still have the rule of law here. We still have intellectual property rights. We don’t have stifling labor union rules that make our workers noncompetitive in the global market. And don’t forget the United States is full of consumers who love to buy things.

A second reason our dollar is gaining strength is that our competitors are weakening their currency on purpose. The fact is that Japan, Europe and China need to sell a lot of stuff to us. When they cheapen their currency, it makes all of their products seem to be “on sale” for American buyers.

How do Japan, China and the Eurozone countries cheapen their currency? It’s simple. They just tell the world they are willing to print copious amounts of money. They don’t actually have to print money; just say they are going to do it.

Here is an example. In November 2012, just prior to his election, Japan’s Prime Minister Shinzo Abe said, “If we come into power, we will implement bold monetary easing through tight coordination with the Bank of Japan.” He called for “unlimited” easing.

The phrase “easing” is just a euphemism for printing lots of money.

Here is an example of how the Chinese view the situation. In March 2013, the president of China’s huge sovereign wealth fund said, “The currency war situation is quite severe. China is definitely a victim.” He warned Japan against using its neighbors as a “garbage bin” by deliberately devaluing the yen.

Europe has maintained a high profile regarding its currency as well. Mario Draghi is the president of the European Central Bank. In a February speech, he said, “I don’t have a cool attitude at all with respect to these levels of inflation.” Inflation is too low in Europe. Remember how you can get inflation? You threaten to print money to lower the value of your currency.

Here is “takeaway” theorem number two:

A weaker Euro is likely to cause higher inflation in Europe.

America has complained for years about how the Chinese manipulate their currency so that Chinese goods are cheaper than American-made products. Just a few months ago, the Treasury Department stated diplomatically that the Chinese currency is significantly undervalued. U.S. Senators Sessions and Brown stated it more precisely: “China’s currency manipulation weakens our economic recovery and makes U.S. exports less competitive, which is why we must combat it with every tool in our toolbox.”

Some people refer to these tactics as a “currency war.” The idea is that each country devalues their own currency so that their products are the cheapest in the world. They get market share all over the world, and other countries lose employment and wealth. In my opinion, the United States and other countries are continuously in a currency battle and have been for decades. It’s not something new.

If you find this topic interesting, a good book to read is Currency Wars by James Rickards.

Here’s the bottom line. Our economy is one of the strongest on the planet right now. We are talking about raising interest rates. When we do, more money will flood into U.S. bonds. This will make the dollar even stronger, and this will reduce the likelihood of inflation in America. How long will this deflationary trend persist? Until other parts of the world become more attractive to investors, causing them to sell U.S. assets and move their funds out of the country.

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Quantitative Easing, Part 2

In my previous blog post, I mentioned that all the trillions of dollars the Fed has “printed” actually has not been printed. The new money has largely been parked in the form of excess reserves in the largest banks. The post concluded that as long as the money remains parked in excess reserves, inflation is likely to remain in abeyance.

The next logical question is: What happens when the money gets up and drives out of the parking lot and into the shopping malls? Isn’t that when we get runaway inflation for sure?

What would have to happen for all this money to get “printed” and into the economy? The excess reserves must be loaned out to consumers, businesses and investors. If consumers borrowed and spent $2 trillion in a short time, prices would certainly go up. If investors borrowed $2 trillion to build new office buildings, retail shopping centers and hotels, prices would certainly go up.

Of course, the Fed has plans to prevent this from happening. Its game plan has three parts: 1) paying interest to the banks on their excess reserves, 2) using reverse-repurchase options to soak up excess cash in nonbank institutions and 3) raising the Federal Funds rate.

In the past, the Fed would just raise the Fed Funds rate until it got high enough to choke off excess loan demand. In effect, the Fed would outbid consumers and businesses for the loanable funds. It would make rates go high enough until loan demand was reduced to desirable levels. To accomplish this, the Fed would actually sell bonds it owns to the banks. This removes lending capacity from the banks and effectively ends the worry about excessive lending and any threat of inflation.

However, the future is not the past. In 2014, the Fed doesn’t want to sell the bonds it holds back to the banks. The Fed worries that if it does this, the interest rates on longer-term Treasury bonds and mortgage rates for homebuyers could increase and choke off the economic recovery.

So how does the Fed soak up the excess cash without selling bonds back to the banks? It will pay banks interest on their excess reserves. If and when the Fed feels the pressure of rising inflation, it will pay banks a high enough rate to encourage them not to lend to private sector businesses and consumers. In effect, the Fed will outbid the private sector for loan funds.

The second tool is referred to as reverse purchase agreements (affectionately referred to as reverse repos). Because the Fed doesn’t want to sell the bonds it owns, why not sell them to banks and money market funds for a few days, weeks or months and then buy them back at a higher price? Sound complicated, esoteric and bewildering to the average American? It is.

But the bottom line is that the Fed will structure these reverse repos so that banks and money market funds will continue to park their cash with the Fed and not go overboard in lending to the private sector. The profit on these repos must be high enough to entice banks and money market funds to choose to buy them rather than make loans to the private sector.

If and when our economy gets strong enough that consumers, businesses and investors want to borrow trillions of dollars in excess reserves, the Fed will raise interest rates on excess reserves and reverse repurchase agreements high enough to entice lenders to keep all that money safely parked with the Fed and not spend it at the shopping mall.

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