2014

Economy 2014

I guess that it is time for some educated guesses and opinions about the economy in 2014.

GDP and Jobs

GDP will likely continue at about a +3.0% growth rate. This is good but does not generate enough tax revenue to keep constant or lower the ratio of debt/GDP. When people talk about deficits or the National Debt what should get the most attention is the ratio of debt/GDP. It is GDP and income which generate the revenues to service the debt. As I have discussed here previously the fact is that the present value of the underfunding of Medicare and Social Security is 4-5 times the size of the National Debt. No one in the government seems concerned about this.

Jobs continue to increase but the concern is that we are always getting bad schooling by the media. What should get the most attention is not the monthly increase in jobs of the unemployment rate but the portion of the adult population working. Jobs have barely been keeping pace with population growth and the percent of the population working continues to slowly decrease.

My point here is that the media concentrates on the wrong numbers. For our long-term national fiscal health we should look at the ratio of debt/GDP. For jobs we should look at the labor participation rate (percent of adult noninstitutionalized population who are part of the labor force). This was 63.0% in November and 63.6% a year before. Also, the inconsistency in the Household Survey makes it difficult to determine the real size of the labor force.

As 2014 starts a very large amount of people (about 1.3 million) will be losing their extended unemployment benefits. These people will either get a job or drop out of the labor force and this will affect the BLS jobs data for the next few months.

Inflation

Generally home loan rates move with the perception of inflation. It has been so long since we have had any significant inflation that the markets are now affected by more subtle factors.
CPI-U in November 2013 was 111% of what it was in November 2007. This is an extended period of low inflation.

QE and Monetary Policy

It is interesting that the Fed is reducing the monthly size of the expansion of Money Supply. I question the extent to which QE had benefited the economy. Most of the expansion of money supply had would up as excess reserves parked at the Fed and consequently doing nothing other than earning interest for banks. The issue I question is this: with this gigantic increase in monetary base ($874 billion in September 2008 to $3.67 trillion in December 2013) will that extra money become a source of inflation if the economy improves? The Fed will have to start reducing monetary base as the economy improves and my concern is that we are moving the starting point constantly higher.

Monetary Base is cash is circulation plus excess reserves at the Fed. This is sometime called “hot money” because it is there to either be spent or loaned immediately.

The reduction in the size of the monthly QE has seemingly sent Treasury and home loan rates up but the fact is that the demand for home loans has dropped faster that the drop in QE so the demand/supply is actually smaller.

One thing which QE3 has done is increase equity values. Remember that QE is the Fed purchasing Treasury and MBS debt for cash. The previous holders of that debt now have cash and clearly they invested it in equities pumping up equity prices and, to some extent, created a wealth effect meaning people now being wealthier because of the increase in the values of their portfolios are now more likely to spend. The extent of the wealth effect of GDP in not really known.

Most economists seem relatively unfazed by the large increase in Monetary base pointing out that the Fed has a good history of being able to draw down Money Supply and Monetary Base before inflation can take hold. The issue in my mind is that there has never been a monetary base expansion on this scale before.

Housing

Mortgage Applications in the week ended 12/20 were at a 13-year low. Much of this is due to fewer refinance applications because of higher rates. New Housing Start (in units) is now just over 1 million per year. We need about 1.5 million per year to keep pace with population growth assuming a constant headship ration (people/household.) Before the Great Recession we had too much home building and since then we have had too little.

Home prices have been increasing at what I regard as a too fast pace. I look for the rate of increase in prices to slow. In general, people spend too large a percentage of their income on housing.

New Home Loan Rules

A week from today the new QM (Qualified Home Loan) rules will take effect. This creates safe harbor for lenders who follow the rules. There are at least 2 issues which will make it more difficult to get mortgages: 1) the maximum debt ratio for QM’s is 43% (as opposed to FNMA’s 45% or FHLMC’s 49.99%) and some of the rules for calculation monthly debt make it tougher to qualify.

The irony is the one of the root causes of the Great Recession was irresponsible lending mandate by HUD consequent to the National Homeownership Strategy. One thing I have learned is that the government has so much voice that it is able to suppress the public’s understanding of what happened. The only story we hear is that greedy bankers did this. Few people other than myself have pointed to the role of the national Homeownership Strategy as a cause of the Great Recession.

One thing I believe we will hear about a year from now is that mortgage lenders by following the QM rules have a policy which is creating a “disparate impact” on socioeconomic groups.

What concerns me is that by defining QM’s CFPB has potentially created a predisposition that non-QM loans are sketchy or, perhaps, predatory. Banks may potentially be sued by those claiming that they are able to make loans which do not satisfy the QM rules and by not making those loans banks have discriminated. This could become a National Homeownership Strategy 2.0 but my views here must be regarded as speculative.

Politics

The government has spent the past 5 years convincing people that it had no hand in the mess and that greed, evil “banksters” did this. This is part of the disconcerting political theme of convincing a large number of voters that corporations and the wealthy are evil. The combination of new home loan rules and constant attacks on the banking system represent threats to anyone making home loans.

 

Obamacare

The rules seem to change daily so I have no idea what the effect of this will be on disposable spending or hiring.

 

What to Watch

I pay a lot of attention to data and find media analysis of data to be very poor. What people should be paying attention to are these things:

– Labor Participation Rate not Unemployment rate

– the ratio of debt/GDP