Tuesday, January 27, 2015

Size Matters in Employment

It is always fun to check on the recent validity of eternal truths. For example, I was shocked to learn one day that if a tree fell in the forest you could not hear it if you were talking on your cell phone. I was also surprised to learn that JD is not an elixir and will not prolong my life past 100 years.

So I decided to check up on another truth – that small businesses are responsible for all or most new jobs in America. I hear people make that claim all the time. For example, I was having a JD on ice at a local tiki bar when the lady sitting next to me whispered in my ear – hey fella what do you think about the proper size of an NFL football? Not knowing the correct answer I whispered back – most jobs in the US are created by small businesses. She toddled off shortly thereafter.

Now that I have your attention, I can move ahead. Who really cares whether jobs are created by your local dry cleaner or by Amazon.com? A job is a job. In fact the job at Amazon probably has better benefits and security. I know that some of you think that bigness creates meanness and that AT&T and GM have it in for workers. But those of you who think that way probably never had a job at one of these small companies. I recall one summer working for a landscaper who yelled at me when I accidently almost cut my arm off with his power saw.  I am not sure if the guy was ever sober one time we worked together.

My point  today, however, is not to irritate small business or to argue with the zillions of fine people who believe that small businesses were invented by God and are the sole source of all good things including JD. My goal in writing this blog post is simply to look at some data that measure recent job change in the USA by size of company. And doing that I have to admit was almost as fun as teaching a three hour class at 9 am  at Big Arts.

Below is a table of numbers I constructed after visiting the Bureau of Labor Statistics web page (http://www.bls.gov/news.release/cewbd.t04.htm ). I take no responsibility for the definition of small or large or what is in between. I will also refrain from any jokes about the meaning of small or large since I know that my readership is above such things. But I do recall a joke about relativity and women’s technical skills in which a man holds his fingers one inch apart and explains to the woman that the distance between those two fingers is exactly six inches.

The BLS has decided to divide private sector companies into three size groups – 49 or less employees; 50-249 employees; and 250 or more employees. They published data for each size cohort for the years 2004 to 2013. Their data is by quarter so I added the quarters to get yearly totals. Their data set has employment gains and losses for each quarter for each size cohort. I have netted the losses from the gains to get the net increase or decrease in each year for each size cohort.

The numbers are pretty interesting. The first set of sums in the table below show how many jobs were created in those 10 years. Below the sums are the averages per year. Roughly 330,000 jobs were created each year. Small companies created 103,000 per year (31%); Medium firms 171,000 per year (52%) ; large companies 55,000 per year (17%).

So you might conclude from these past 10 years that small companies were responsible for about a third of the net jobs created in private companies. That is a nice hunk of jobs buy clearly is nowhere near even a majority.

But let’s take this another step. The years 2008 and 2009 were unusual. While large companies typically account for a minority of the jobs gained in expansionary years notice that the larger companies accounted for nearly 7 million job reductions in 2008 and 2009. Small business lost less than half that amount. So let’s remove those two years and look at the 8 remaining years in which there were net job gains. If we believe those 8 years are more typical for accessing job gains – then the picture changes radically. The average increased employment of the larger firms was about 927,000 jobs per year. Small firms accounted for about 563,000 jobs per year.

Whoa Nellie you say. Larry – you can’t throw out the numbers you don’t like. That’s true. But it is also true that neither set of averages is perfect. Leaving in two very atypical years distorts our conclusions. Removing those two years equally taints the data. Without any easy or obvious third way, I think it is safe to say that both sets of data inform us. Weighing both together suggests that we not discriminate against the bigger firms when it comes to finding ways to expand US employment. It just ain’t true that small firms are the only sources of job growth.

Table. Net Job Change Private Sector Companies
2004 to 2013 by Size of Company
Thousands of jobs

0 to 49
50 to 249

Tuesday, January 20, 2015

The Ghost of Christmas Future: If Scrooge Can Change Why Can’t We?

Dickens’s Scrooge woke up and was relieved to know it was all just a dream. And he had time to change his ways before a very ugly future unfolded. Aren’t Christmas tales fun? You get a second chance.

Our government and our Fed will get a chance to save us from an ugly future. Let’s hope they are as salient as Scrooge. But then Scrooge didn’t have to be re-elected or face the press each day.

Larry stop cracking your knuckles in the living room. My mom often warned me that if I kept up that annoying habit that someday my hands would be a mess. I should have listened to mom.

I took a look at the bi-partisan budget outlook published by the Congressional Budget Office last August (cbo.gov). It amazes me how little attention it is getting. The warning could not be any clearer but alas our elected leaders will spend their time on a prison Cuba, arguing the correct name for terrorists, and giving young people free Community College experiences. Not that these issues are unimportant but it is pretty clear that we are putting ourselves in extreme financial jeopardy by ignoring or papering over what our government is doing to us—and our progeny.

I have moaned about the concept of jeopardy in this space before. I am not speaking of Alex Trebeck. Jeopardy is a state of being that opens you up to consequences. When you try to scale a vertical cliff, you put your health into jeopardy. When you wear last year’s trousers that are a bit too tight, you put yourself into social jeopardy. When the government creates too much debt it puts our economy and millions of jobs into jeopardy.

Many of my blue friends are saying – Larry quit your whining. The unemployment rate is down and the economy is growing. Roses are blooming and young women are wearing yoga pants. What could be better! I can think of a lot of things that could be better but I will try to stick to my message. Jeopardy means that today the cool breezes are flowing through your ample locks – but that also means you might land on your head tomorrow.

When things are good is the only time you can prepare for the future. So if you miss that opportunity then things will only get worse. When you are young and your income is ample and rising, that is when you save for the future. If you do the saving, then when misfortune hits, you can take care of yourself. It is pretty simple. You DON’T wait until after the loss of employment to decide it is a good time to save money.

And that is what we threaten to do now with our country. Go to cbo.gov and look at the tables in the August report cited above. Before the last recession our net national debt held by the public (the gross debt is much bigger) was $5 trillion and about 35% of the economy. By 2014 it had risen to almost $13 trillion or 74% of the economy. It is expected to rise to almost $21 trillion by 2024.  It will then be 77% of the economy.

Some of you will say that 70+% net debt is sustainable – at least for a while. The debt exploded during a recession and the following slow growth time period. But notice that it is getting even bigger during a future time characterized as at least moderate if not strong economic growth. So if our representatives do not make major strides to fix the debt, it isn’t going to fix itself. The economy is not going to fix it either.

But that story is too optimistic. The recession lasted through 2009. That means it has been almost six years since the last recession. Which means another recession is coming.  I won’t quote the average time between recessions but clearly it is highly unlikely that we won’t get a recession in the next few years. If you look around at what is happening in China, Japan, Greece and so on…you realize that the chances of a US recession are improving all the time.

If we do enter a recession or a very slow growth period what do you think is going to happen to the US budget? Correctomundo– tax revenues will fall, expenditures will rise, the deficit will widen and the debt will grow. If you were comfortable with a net debt of 77% then how about a debt of 100%? How about 150%? Is there a point at which you will admit that something needs to be done? Why not do it now before we reach than unenviable rock and hard place?

Some of you will puff out your chests and note that our deficit came down to $0.5 trillion in 2014. But that doesn’t help. The CBO report projects a deficit every year through 2024 rising each year to an amount equal to $1 trillion in 2024. I hate to tell you but that is not progress. That is like the 240 pound guy who gains 5 pounds a month and reaches 300 pounds during the year saying he is going to start gaining only 3 pounds a month as a way to lose weight. He is going to weigh 336 next year!

That’s what we are doing with the nation’s deficit and debt. Current projections say it will go from about $13 trillion in 2014 to almost $21 trillion in 2024. It won’t be easy to get this country on a real empowering diet. The main problem is that we are already hemmed in by so-called mandatory spending and net interest growing by about $2 trillion over the next 10 years. If we don’t stop mandatory spending, then we don’t have much else to work with!

I have punished you enough today. The President plans to punish you even more tonight. Tell him it is time to address the national debt. 

Tuesday, January 13, 2015

Potpourri from Guest Blogger Buck Klemkosky

The U.S. Economy Accelerates
The Buck’s at an 11-Year High
The U.S. Baby Bust
TARP Ends With a Profit
Less Liquidity = Bond Market Turbulence

The U.S. Economy Accelerates

The Great Recession ended in June 2009. The 5.5 years of economic recovery and expansion since has been slow and uneven until 2014. The year started off with negative economic growth of 1.9 percent in the first quarter but GDP growth accelerated to 4.6 percent annualized growth in the second quarter and 5 percent in the third quarter of 2014. These are the best two quarters of GDP growth since 2003 and the 5 percent third-quarter growth was the first since the recession ended.  The third-quarter growth was driven by personal consumption expenditures, especially for services, government expenditures and manufacturing output.

Recent consumer confidence surveys are at the highest levels since the recession ended. This increased confidence can be attributed to the 2.7 million jobs growth in the first 11 months of 2014, plunging energy prices, low inflation and interest rates, household finances in better shape and a stronger financial system. The consensus forecast of 2015 GDP growth is 3 percent, which is the average U.S. growth rate since 1965. After subpar 2.3 growth since 2009, the average looks pretty good.

But there are headwinds, especially from abroad as the U.S. stands alone among the developed countries of the world in economic growth; Europe is barely growing; Russia is headed for a recession, and Japan is already in one. China’s growth is down to 7.0-7.5 percent in 2014 and lower growth is expected in 2015 as it tries to transition from an investment to a consumption-driven economy. Any global economy that is dependent upon energy production or commodities will have difficulty achieving positive economic growth in 2015. A stronger dollar could also slow U.S. economic growth in 2015.

The Buck’s at an 11-Year High

2014 has been the year of the U.S. dollar. It has strengthened (appreciated) 13 percent against a basket of global currencies to its highest level since 2003; 12 percent against the Euro and Japanese yen, and 9.4 percent against the Canadian dollar, and 14.7 percent again the Mexican peso. About the only countries not to have their currencies depreciate against the dollar were those that peg their currency to the dollar; that would include China, Singapore, Saudi Arabia and a few others.

Why the strength in the U.S. dollar? The U.S. economy is accelerating relative to a stagnant Europe and slowing Asia. Plus the U.S. appears to be about the only developed country ready to raise short-term interest rates in 2015. A combination of better economic growth and higher interest rates makes the U.S. a more attractive place to invest. So capital flows from abroad have been somewhat responsible for the surging dollar, helping to lower U.S. long-term interest rates and inflation.

The risk of a strengthened dollar to the U.S. is that exports will be less competitive in global trade and may affect economic growth. But the risks are much greater for those countries that are exporters of oil and other commodities, as reflected in the dramatic fall in the value of the Russian ruble and Venezuelan bolivar. The risks to any foreign country or company that have borrowed in U.S. dollars will be particularly severe as it will take more local currency to pay back a dollar of interest or principal. Another concern is that the currency realignments may lead to competitive devaluations, which used to be called currency wars. Japan has already used this to kick start their economy and inflation. Others may follow.

The U.S. Baby Bust

The Great Recession and financial crisis of 2008-2009 has impacted the fertility rate in the U.S., resulting in one of the lowest on record. In 2007, the U.S. had 69.3 babies born per 1000 women of child-bearing age; in 2013 that had fallen to 62.5 babies per 1000 women. The fertility rate has fallen to 1.86 in 2013; a rate of 2.1 is needed to stability the population. If 2007 fertility rates had prevailed, there would have been 2.3 million more births than actually occurred from 2007 to 2013.

There has been a long-term structural decline in the U.S. fertility rate from 3.7 in the 1950s to 1.8 in the late 1970s. This decline can be attributed to later marriages, increased college attendance and labor-force participation by women, advances in birth control, the higher costs of raising a family and the higher divorce rate. There was then a gradual increase in the fertility rate from the 1970s low to 2.1 in 2007.

The decline in the fertility rate since 2007 is a result of the Great Recession. More than half the decline in births since 1970 can be explained by a one-third decline in the birth rate of Hispanic women. In 2007, Hispanic females accounted for 17 percent of the women in the 15 to 44 age group but had 25 percent of the babies. Their birth rate of 2.4 today is slightly above the replacement rate. The other half of the decline in births is due to white and black women having a slightly lower fertility rate, again a result of the recession.

The birth rate has declined in past recessions, but not to the extent of the last six years. If the birth rate permanently stays below the replacement rate of 2.1, it means less population growth, slower economic growth, and less consumer spending. It also means the U.S. is following the Eurozone countries, Russia, China and Japan in demographic trends. The economic consequences will be noticeable and long lasting.

TARP Ends With a Profit

Remember TARP, the Troubled Asset Relief Program, which was passed by Congress in October 2008 in the depths of the financial crisis? It was just after the Lehman Brothers bankruptcy and the financial system was on the verge of collapse. It was and still is a controversial bailout package that never won public support. In fact, the first TARP bill was rejected by Congress but a second version passed a week later. The U.S. government approved $800 billion of bailout funds including about $426 billion of TARP funds.

TARP bailed out banks, including Citigroup and Bank of America, American International Group, General Motors, Chrysler and hundreds of other firms with debt and equity support. The government also took over two major mortgage firms, Fannie Mae and Freddie Mac, which purchase mortgages from originators. In total, the government funded almost $700 billion of bailouts including the $426 billion of TARP funds. The takeover of Fannie Mae and Freddie Mac required $187 billion of government funding but was not part of TARP.

In December 2014, The U.S. government closed the books on TARP when it sold its remaining shares of Ally financial, the former General Motors Acceptance Corp. After six years, TARP was closed with a profit of $15.3 billion, a return of 3.6 percent. Probably not a sufficient return given the risk involved, but most had not expected any profit at the time. The U.S. government made money on the bank bailouts and AIG. It lost money on the auto bailouts and the takeover of the two mortgage companies. About 35 small community banks remain in the program, down from 700 financial institutions at the height of the program. For all intents and purposes, the TARP books are closed with a profit. The government still owns Fannie Mae and Freddie Mac, both of which are profitable and will soon repay their $187 billion of bailout funds in full.

The major criticism of TARP and other bailout funds is that it put Wall Street ahead of Main Street by not helping troubled homeowners who have received about $15 billion of assistance out of $75 billion promised. But TARP and the whole bailout program has to be considered a success in terms of stabilizing the financial system and the economy. The complete collapse of several large banks, General Motors, Chrysler, AIG and others would have been catastrophic and ended up costing taxpayers hundreds of billions of dollars more than the cost of TARP and other bailout funds. Think trillions.

Less Liquidity = Bond Market Turbulence

October 15, 2014 will be a date long remembered in financial markets similar to the May 10, 2010 flash crash when the Dow Jones Industrial Average lost 1000 points in a few minutes and October 19, 1987, when stock markets of the world declined 20 percent or more in a single day. Maybe not a day of infamy, but an important day.

On the morning of October 15, 2014, the benchmark U.S. 10-year Treasury bond had been trading at a 2.2 percent yield to maturity. As U.S. trading opened, the yield started to drop and within minutes it tumbled to 1.86 percent, a drop of one-third of a percentage point. This drop in yield was of historical proportions and was considered a 7 standard deviation event; to put that in perspective, this is something that should happen every million years or so, given the historical volatility of U.S. 10-year Treasury bond yields. By the end of the day, nearly $1 trillion of Treasury bonds had traded and billions more in the derivative markets and the yield on the U.S. 10-year Treasury bond had recovered to 2.14 percent. Bond yields are inversely related to bond prices, so U.S. Treasury bond prices rose initially and then settled back as yields rose. What had prompted the rush into treasuries was disappointing economic news and a flight to safety because of geopolitical events.

The Treasury bond market is the deepest and most liquid of all markets in the world as $12.5 trillion of Treasury bonds are in public hands. What bothers investors and regulators alike is that this October experience in the Treasury bond market may foretell the future volatility in the U.S. corporate bond market. The U.S. corporate bond market has about $9 trillion of bonds outstanding, an increase of about 50 percent since the Fed started to lower interest rates in 2008. In the U.S. there are about 5,000 different common stocks that are publicly traded; however, there are 47,000 different corporate bonds outstanding. So the liquidity and ease of trading a particular bond issue is not like trading a stock; it’s riskier on average.

This risk has become accentuated by an unintended consequence of the Dodd-Frank law passed in 2011. Under the co-called “Volcker Rule,” banks are prohibited from proprietary trading, trading for their account, and new capital rules make it more costly for banks to hold assets and securities needed to ensure liquid markets. So banks have dramatically reduced the amount of capital devoted to bond trading; one estimate has dealers’ inventory of corporate bonds declining 75 percent from $200 billion to $50 billion since the financial crisis. Thus liquidity in the bond markets has been dramatically reduced.

After the financial crisis of 2007-2008, investors placed more than $1 trillion into bond mutual funds, exchange traded funds and other institutional money managers. The money was invested in bonds because of low Fed-induced short-term interest rates and stock market losses in 2008-2009. It was deemed a safer investment and investors were chasing yields. Given the combination of a much larger corporate bond market and less liquidity available for trading corporate bonds, many worry about what happens when interest rates start to rise and bond investors head for the exit. The big question is whether the exit door is wide enough to let everyone out without causing major disruptions in the market. 

*Buck is Market Strategist at Wallington Asset Management.

Tuesday, January 6, 2015

Ghost of Christmas Past: Looking Behind to Look Ahead

Stock markets are up then down. The value of the dollar is soaring while the ruble and many other currency values plummet. Are we going back to another recession? Didn’t we just get out of a recession? Are we doomed to decades of slow growth? Was Elvis a transsexual? These are just some of the questions being asked these days.

To oversimplify what is going on now is risky but why have a blog if you aren’t willing to stick your neck out? It seems to me that what is going on today reflects an ongoing evolution of the global economy. In the rich places of the world we are playing out a dramatic financial evolution. In the wanna-be-rich places of the world we are seeing the results of logical but unfortunately dangerous economic development policies.

Whether we focus on Russia or Venezuela there are similarities. These countries are trying to catch up to their richer neighbors. Impoverished by rigid autocratic and socialist policies before the 1990s, these and other so-called emerging or developing countries plunged into less regulated and more market-oriented systems. Just as when an old man tries to learn to play the guitar, the physical, cerebral, and other transitions required in such a transition are slow and painful. No country found transition easy and no country did it the same way. But by the dawn of the 21st century many were finding success in global capitalist markets. And some of the ones with the most startling successes were those that chose to specialize – or build their new economies around one or a few industries often featuring the exportation of commodities like oil, copper, and aluminum.

And so it was in 2007 when the signs of economic slowdown first became apparent, a catchword was "decoupling". That is, the developing countries had advanced so far that even if the US or other rich countries experienced recessions – the developing countries would be fine. They had decoupled their economic growth from industrial world. Well—that was optimistic and mostly wrong. Just as a one-handed juggler of flaming knives finds out – when the going gets rough it helps to have two hands! Building your economy on only a few sectors means you have nothing to fall back on when those sectors experience difficult times.

Human nature and politics suggest that we should not be too critical of developing nations. It is not easy to dig from the ruble of failed socialism and build a broad, dynamic for-profit economy. And once you get a few sectors humming, it is tough to divert resources away from the successful ones to build the lagging parts. Critical or not, as the world languishes in slow growth, these one horse countries are not going to quickly or easily return to the heady days. One reason is that world growth may take awhile to recover. The other reason is that bad policy seems to follow bad policy. 

Excessive debt and inflation hamper what can be done with traditional Keynesian policies. Most of these countries are raising interest rates to defend against currency depreciation and inflation. Many are going through fiscal contraction because of excessive debt. They are between the proverbial rock and hard place.

This brings us to a JD break and a brief discussion of the other countries – the rich ones. These countries might be richer but they are not necessarily smarter and are not immune from historical evolution. They may not have one-horse economies, but as Brian Westbury often writes, they have created plow horse economies. Perhaps in the name of “progress” or because of sophisticated caring for people and resources – the richer countries have saddled capitalistic engines with more regulations, higher taxes, higher government debts, and uncertain business environments. It is interesting that while an energy revolution has finally strengthened the US in economic and security terms – there are those in politics who want to throw even more regulations, costs, and uncertainty on US firms.

To bring this all together, it is unexplainable that the rich and not-so-rich cannot learn from each other. The rich should vividly see that too much debt and regulation can virtually destroy a country’s economy and leave it with no good policy alternatives.  The less-rich need to see that reforms to widen the economic base are necessary for future growth.  The past should inform us.