Monday, March 6, 2017

Do You Want to Restore Manufacturing Employment? Smash the Robots!

March 6, 2017

Do You Want to Restore Manufacturing Employment? Smash the Robots!

There has been much public discussion about the demise of U.S. manufacturing jobs and policies to restore manufacturing employment. Indeed, as shown in Chart 1, in absolute as well as relative terms, U.S. manufacturing employment has declined in the post-WWII era. In absolute terms, U.S. manufacturing employment started falling precipitously in the 2000s and has been especially hard hit since the Great Recession.  (Shaded areas in this and subsequent charts represent periods of economic recession.) U.S. manufacturing employment relative to total U.S. nonfarm employment has been trending lower throughout almost the entire post-WWII era. While relative manufacturing employment has been trending lower for almost 70 years,  manufacturing’s relative contribution to total real GDP (see Chart 2), after ebbing during the 1980s and early 1990s, staged a resurgence in late 1990s until the Great Recession. Although foreign trade is being advanced by some as the reason for the secular decline in U.S. manufacturing, I will argue that technology is the principal factor accounting for this phenomenon.
Chart 1
Chart 2

Let’s examine the relationship between U.S. net exports of goods and manufacturing output relative to total output. Plotted in Chart 3 are annual averages of U.S. real net exports of durable goods (real exports of goods minus real imports of goods) as a percent of total real GDP and annual averages of real GDP value-added of manufacturing as a percent of total real GDP. U.S. manufacturing output relative to total real GDP reaches a post-WWII low in 1981 and climbs back to its highest level since 1972 in 2006. Notice that as U.S. manufacturing relative GDP was oscillating higher from the early 1980s through the mid 2000s, the U.S. real net exports in durable goods relative to real GDP was oscillating lower. For historical reference, NAFTA was signed in 1994, the U.S. joined the WTO in 1995 when it came into existence and Mainland China joined the WTO in December 2001. So, U.S. manufacturing started making greater contributions to total GDP after NAFTA and after Mainland China joined the WTO. That is, U.S. manufacturing started making greater contributions to total GDP as the U.S. trade deficit in durable goods was enlarging up until the Great Recession.
Chart 3
So if foreign trade deficits are not a satisfactory explanation of the secular decline in U.S. manufacturing employment, what is? A secular increase in manufacturing-worker productivity. The data in Chart 4 compare the real GDP value-added of manufacturing per manufacturing employee, a crude measure of manufacturing-worker productivity, with the total number of manufacturing employees. Both series are converted to index numbers with their respective 1950 values set equal 100. If manufacturing workers are becoming more productive over time, that is, as time progresses, one manufacturing employee is able to produce a greater real value of manufacturing output than in previous years, the index number of the real GDP value-added of manufacturing per manufacturing employee would be higher. In fact, in 2015, this index number stood at 776. This means that a manufacturing worker in 2015 could produce 676% more output than she could in 1950 (776 represents a 676% increase vs. 100). This translates into a compound annual rate of growth in this crude measure of manufacturing-worker productivity of 3.25% from 1950 through 2015. The index number of total manufacturing employment in 2015 stood at 88, meaning that there were 12% fewer manufacturing employees then compared to 1950 (88 represents a 12% decline vs. 100). Given the secular increase in manufacturing-worker productivity, it is not surprising that there has been a secular decline in the number of people employed in manufacturing.



Chart 4
The data in Chart 5 help explain the secular increase in manufacturing-worker productivity. Along with the index of real GDP value-added of manufacturing per manufacturing employee, again a crude measure of manufacturing-worker productivity, I have added the index of the real net stock of business equipment per manufacturing employee – a crude measure of the capital-to-labor ratio in manufacturing. Give a woman a brace-and-a bit set, and she can drill more holes in a given amount of time. Give a woman an electric drill, and she can drill even more holes in the same amount of time. Give a woman a drilling robot to run, and she can drill yet even more holes in the same amount of time. In other words, the more equipment and more technologically-advanced equipment a manufacturing worker has to work with, the more output can be produced by that worker in a given amount of time. As the capital-to-labor ratio in manufacturing rises, so should worker productivity rise. And that is what the data plotted in Chart 5 indicate.
Chart 5



The moral of this story is that if America wants to restore manufacturing employment to its former glory, the federal government should form a search-and-destroy task force with the authority to enter manufacturing facilities in the U.S. to smash robots, computers and any other labor-saving equipment the deputized task force deems appropriate. Then there will be a tremendous increase in demand for U.S. manufacturing employees. Of course, manufacturing output will grow more slowly and the prices of manufactured goods will skyrocket. But, hey, the goal of increased manufacturing employment will have been achieved.

Paul L. Kasriel
Founder, Econtrarian LLC
Senior Economic and Investment Advisor
1-920-818-0236

“For most of human history, it made good adaptive sense to be fearful and emphasize the negative; any mistake could be fatal”, Joost Swarte


Tuesday, January 17, 2017

2017 -- Shades of 1937

January 17, 2017

2017 – Shades of 1937

As a result of some Fed actions taken in 1936 and 1937, the U.S. economy, after experiencing a robust economic recovery starting in early 1934, slipped back into a recession midyear 1937, which lasted through midyear 1938. Based on the recent slowdown in thin-air credit growth,  I believe that a significant slowdown in the growth of nominal and real U.S. domestic demand will commence in the first quarter of 2017. The duration and magnitude of this slowdown depends on the future behavior of thin-air credit.

Let’s briefly review the U.S. monetary history of 1936-1938. In response to the robust recovery the U.S. economy was experiencing and the high level of excess reserves the banking system was maintaining, the Fed, in a series of steps between August 1936 and May 1937, doubled the percentage of cash reserves banks were required to hold against their deposits. The Fed believed that these de jure excess reserves held by banks were de facto excess reserves. That is, the Fed did not believe that banks desired to hold the amount of de jure excess reserves that were in existence. If these reserves held by banks truly were in excess of what they wanted to hold, then it was surmised by the Fed that banks would engage in the creation of new credit for the economy by some multiple of the existing excess reserves. If this creation of new bank credit were to occur against a backdrop of an already robust economic expansion, the U.S. economy would be in danger of overheating.  As a result of this reasoning, the Fed chose to “sterilize” some of these excess reserves by converting them into required reserves.

As it turned out, with the experience of bank runs of the early 1930s still fresh in the memory of bank managers, a large proportion of the existing excess reserves were, in fact, desired to be held by banks. As a result, when the Fed decreed that a large portion of these excess reserves would become required reserves, banks attempted to restore their holdings of excess reserves. In this attempt, banks contracted their loans and investments – bank credit. Because only the Fed can increase or decrease total reserves, this banking system contraction in bank credit did not, in and of itself, increase total reserves. But what it did do was contract bank deposits, which in turn, reduced required reserves. For a given amount of total reserves, a reduction in required reserves implies an increase in excess reserves. Following the contraction in bank credit and the sharp slowdown in the growth of bank reserves, the U.S. economy entered a recession at midyear 1937. In sum, the Fed’s decision back then to double the reserve requirement ratio against bank deposits set in motion a sharp deceleration in the growth of thin-air credit that resulted in a U.S. recession.

Let’s fast forward about 80 years. The Fed has not raised required reserve ratios. But, as shown in Chart 1, the Fed has begun contracting an element of thin-air credit, the monetary base (cash reserves held by depository institutions plus currency in circulation). In 2014, the Fed began tapering its purchases of securities in the open market, which slowed the growth in the monetary base. In 2015, the Fed ceased altogether its securities purchase program and contracted the monetary base at the end of 2015 in order to push up the federal funds rate by 25 basis points. For reasons still a mystery to me, the Fed stepped up its contraction in the monetary base in the second half of 2016, culminating in a further contraction in December 2016 in order to push up the federal funds rate another 25 basis points.




Chart 1
Another major element of thin-air credit, credit created by commercial banks, after cruising along at robust growth rates in 2015 and most of 2016, suddenly decelerated sharply in Q4:2016. I am not aware of any new regulations or credit-quality concerns that would have motivated commercial banks to slow their acquisitions of loans and securities. Yes, short-maturity bank funding rates have crept up in the past two years in response to actual and expected increases in the federal funds rate. For example, in the week ended September 30, 2016, the average three-month LIBOR interest rate was 21 basis points higher than it was in the week ended July 1, 2016. If a 21 basis point increase in bank funding costs caused the quantity demanded of bank credit to slow as much as it did in November and December 2016, then the interest elasticity of bank credit demand is extraordinarily high. And if, in fact, the interest sensitivity of bank credit demand is so high, the Fed might want to take this into consideration in its federal funds rate targets going forward.
Chart 2
Okay, it is a mystery to me as to why the Fed contracted the monetary base as much as it did in 2016 and why bank credit growth fell off a cliff in Q4:2016, but as I amusingly remember hearing in so many corporate staff meetings – it is what it is. So, let’s combine bank credit with the monetary base to see what the behavior of this thin-air credit aggregate has been of late. This is presented in Chart 3. On a year-over-year basis, growth in the sum of commercial bank credit and the monetary base in December 2016 was 2.6%. To put this into historical context, from January 1960 through December 2016, the median year-over-year growth in monthly observations of the sum of commercial bank credit and the monetary base was 7.1%. In the three months ended December 2016, the annualized percentage change in this measure of thin-air credit was minus 0.6%.
Chart 3

So, there has been a deceleration in the growth of this measure of thin-air credit to a rate that is quite low compared to its longer-run median rate. So what? Chart 4 provides an answer to this question. Plotted in Chart 4 are year-over-year percent changes in quarterly observations of nominal Gross Domestic Purchases and of the sum of commercial bank credit and the monetary base. The year-over-year percent changes in the sum of commercial bank credit and the monetary base are advanced by one quarter in order to be consistent with my hypothesis that the behavior of thin-air credit leads or “causes” the behavior of nominal Gross Domestic Purchases. Gross Domestic Purchases are defined as Gross Domestic Product minus exports plus imports. The correlation coefficient between these two series from Q1:2012 through Q3:2016 is 0.71. If these two series were perfectly correlated, the correlation coefficient would be 1.00. So, although not a perfect relationship, there does appear to be a relatively close positive relationship between changes in this measure of thin-air credit and changes in nominal domestic purchases of goods and services. With the year-over-year growth in this measure of thin-air credit slowing from 3.9% in Q3:2016 to 2.6% in Q4:2016 (indicated by the Q1:2017 blue bar in Chart 4 because growth in thin-air credit is advanced by one quarter), this augurs poorly for growth in nominal Gross Domestic Purchases in Q1:2017.

Chart 4
If growth in U.S. domestic demand falters in Q1:2017, as “predicted” by the recent behavior of thin-air credit, then the Fed is unlikely to push the federal funds rate higher until it sees a recovery in demand growth. Even if the Fed holds off on raising the federal funds rate, it still is unlikely to step up growth in the monetary base component of thin-air credit in Q1:2017. As mentioned above, I am at a loss to explain the recent sharp deceleration in bank credit growth. But unless growth in this component of thin-air credit does re-accelerate, then very weak growth in total thin-air credit would likely persist through Q1:2017, which would have continued negative implications for growth in domestic demand for goods and services into Q2:2017.

The Fed’s actions of 1936-37 caused a sharp slowdown in the growth of thin-air credit, which resulted in the recession of 1937-38. It is too early for me to forecast a recession in 2017 because of the Fed’s disregard for the recent growth slowdown in thin-air credit. But I do believe investor expectations of U.S. economic growth will be disappointed in the first half of 2017. All else the same, this economic-growth disappointment has positive implications for U.S. investment grade bonds and negative implications for risk assets such as U.S. equities.

One factor that could stimulate thin-air credit growth would be a sharp increase in federal credit demand resulting from tax cuts and/or discretionary spending increases. This increased credit demand would put upward pressure on the structure of U.S interest rates. If the Fed were unwilling to allow the federal funds rate from rising under these circumstances, then both the monetary base and bank credit would rise in the face of the increased credit demand. It is not a question of if significant federal tax cuts are coming in the next two years, but when and how the Fed will react to them.

Paul L. Kasriel
Founder, Econtrarian, LLC
Senior Economic and Investment Advisor
1-920-818-0236

“For most of human history, it made good adaptive sense to be fearful and emphasize the negative; any mistake could be fatal”, Joost Swarte


Wednesday, December 14, 2016

If You Think the Pace of Economic Activity Is Weak in 2016, Just Wait Until 2017

December 14, 2016

If You Think the Pace of Economic Activity Is Weak in 2016, Just Wait Until 2017

As shown in Chart 1, the year-over-year growth in real and nominal Gross Domestic Purchases (C+I+G) in Q3:2016 was 1.4% and 2.4%, respectively. This compares with 2.8% and 4.7% year-over-year growth in real and nominal Gross Domestic Purchases, respectively, in Q3:2014. So the pace of real and nominal domestic spending in the four quarters ended Q3:2016 was about half that of the pace in the four quarters ended Q3:2014. Notice the green line in Chart 1. It represents the year-over-year percent change in quarterly-average observations of the sum of commercial bank credit (loans and securities on the books of commercial banks) and the monetary base (reserves held at the Fed by depository institutions and currency in circulation). As regular readers (are there still two of you?) of this commentary remember, this sum is what I refer to as thin-air credit because it is credit that is created by the commercial banking system and the Fed figuratively out of thin air. The unique characteristic of thin-air credit is that no one else need cut back on his/her current spending as the recipient of this credit increases his/her current spending. Notice that growth in this measure of thin-air credit, as represented by the green line in Chart 1, has been trending lower since hitting a post-recession peak in the fourth quarter of 2014. Growth in thin-air credit is advanced by one quarter in Chart 1 because my past research has shown that the highest correlation between growth in thin-air credit and growth in nominal Gross Domestic Purchases is obtained when growth in thin-air credit leads growth in nominal Gross Domestic Purchases by one quarter. This suggests, but by no means proves, that the behavior of thin-air credit has a causal relationship with the behavior of growth in Gross Domestic Purchases. So, I believe that the slowdown in the growth of thin-air credit in the past two years has played a major role in the slowdown in domestic spending during this period.
Chart 1
Chart 2 provides some insight as to why growth in the sum of commercial bank credit and the monetary base has been slowing since 2014. The slowdown in the growth of thin-air credit in the past two years is not because banks have been stingy with their granting of credit. On the contrary, as can be seen in Chart 2, year-over-year growth in commercial bank credit (the blue line), after accelerating sharply in 2014, held in a range of about 6-1/2% to 7-3/4% in 2015 and over the first three quarters of 2016. So, despite the increased regulation that banks are now subject to, bank credit growth has returned to a rate approximately equal to its long-run median. No, the culprit has been the Fed. Growth in the monetary base (the green bars in Chart 2), reserves and currency created by the Fed, decelerated in 2014. There was essentially no growth in the monetary base in 2015 and there has been a contraction in it so far in 2016. In 2014, the Fed began to taper the amount of securities it had been purchasing in the open market in connection with its third phase of quantitative easing (QE). This resulted in the deceleration in the growth of the monetary base. In 2015, the Fed ceased its QE operations. In December 2015, the Fed raised its federal funds rate target by 25 basis points. In order to “enforce” this higher federal funds rate, the Fed had to reduce the supply of reserves it created relative to depository institutions’ demand. This resulted in the contraction in the monetary base in early 2016. For reasons still a mystery to me, the Fed has failed to offset the drain of reserves caused by unusually high Treasury balances at the Fed. In addition, the Fed has been draining reserves from the financial system via reverse repurchase agreements, presumably to satisfy the money market mutual funds’ demand for risk-free assets as a result of regulatory changes that when in effect in October 2016. (See my November 1, 2016 commentary “The Fed Began Tightening Policy in October and No One Knew It, Maybe Not Even the Fed” for a discussion of this.) This has resulted in the continued contraction in the monetary base in 2016. In sum, the slowdown in the growth of combined commercial bank credit and the monetary base in the past two years is primarily the result of the Fed’s failure to create enough thin-air credit to prevent the stagnation in monetary base in 2015 and the outright contraction in the monetary base so far in 2016. And I would submit to you that the significant deceleration in the growth in combined commercial bank credit and the monetary base in 2015 and 2016 is primarily responsible for the deceleration in the growth of both nominal and real Gross Domestic Purchases in these years as well.
Chart 2

On December 14, 2016, the Fed raised its federal funds rate target by another 25 basis points. Just as the Fed had to reduce the supply of reserves relative to depository institutions’ demand for them in order to push the federal funds rate up to its higher targeted level in December 2015, it will have to do the same thing in December 2016. This implies a further contraction in the monetary base. Chart 3 shows the year-over-year annual and three-month annualized growth in combined commercial bank credit and the monetary base in the past 12 months. In the 12 months ended November 2016, growth in combined commercial bank credit and the monetary base was 2.7%. In the three months ended November 2016, growth in combined commercial bank credit and the monetary base was a goose egg – that is, zero. To put the recent growth in this measure of thin-air credit into perspective, from January 1960 through November 2016, the median year-over-year growth in monthly observations of combined commercial bank credit and the monetary base has been 7.1%. So, recent months’ growth in this measure of thin-air credit has been exceptionally low, both in absolute as well as relative terms. And, with the Fed’s December 14, 2016 decision to raise the federal funds rate another 25 basis points, growth in combined commercial bank credit and the monetary base will be even weaker in the coming months.
Chart 3

The extreme weakness in the growth in the past three months of combined commercial bank credit and the monetary is not just due to the contraction in the monetary base. As shown in Chart 4, there also has been some weakening in the growth of commercial bank credit, too. To wit, in the three months ended November 2016, the annualized growth in commercial bank credit slowed to 5.6%, the slowest growth since the 5.7% posted in the three months ended November 2015.
Chart 4
Based on published data so far for Q4:2016, the Atlanta Fed is forecasting real GDP annualized growth in this current quarter of 2.4%, down from the previous quarter’s 3.2% annualized growth. With current growth in thin-air credit already very weak and likely to get even weaker after the Fed contracts the monetary base more in order to push the federal funds rate 25 basis points higher, real and nominal U.S. economic growth is likely to slow further in the first half of 2017. Happy Festivus!

Paul L. Kasriel
Founder, Econtrarian, LLC
Senior Economic and Investment Advisor
1-920-818-0236



“For most of human history, it has made good adaptive sense to be fearful and emphasize the negative; any mistake could be fatal”, Joost Swarte