The Real Economic Numbers
Krugman argues for a bicoastal land bubble - while oil hits fresh nominal highs. The signs of inflation seem to be everywhere, except in official government statistics.
The first thing to realize is that a great deal of the "growth" in the US economy is fictional. Inflation numbers are adjusted for what is called "equivalent rent" rather than total home ownership costs. Is this important?
Let's look at the CPI line for "rent of equivalent shelter". The "relative importance" of primary housing is 23.158% This I think is low, because it looks at average rather than median spending on houses, but let's take the good people at the BLS at the word and work with it.
Now inflation in this component is 2.2% In March the annual rate was 2.4%
However according to the Office of Federal Housing Oversight the most recent quarter saw an annualized rate of 8.5% and a year on year rate of 12.5%. Swapping out the rate in in March we get a full year underestimation of inflation of 2.57%
This means that a Keynesian inflation rate - that is one that is closer to a measure of the inflation rate in the economy as a whole - is 5.7%.
The same thing is true with the unemployment rate. The reason the unemployment rate has dropped is because people have left the work force. People out of the work force don't consume as much - they aren't driving to work for example - and they don't act as demand for jobs. But people who are discouraged and have gone over to the cash economy - that is working under the table, scrounging and so on - are still unemployed from the point of view of how they feel. So how do we measure this? There are two steps. One is to look at the recent peak of the labor force participation. That's the econogeek way of saying "what's the largest number of people who are willing to work if there are jobs?" The fast estimation is just to multiply current working age population by that number. This gets a number which is, basically "full employment". Then calculate the unemployment rate from this. The result is 7.1%
More sophisticated is to do a demographic adjustment - that is take the population we have, and figure out what the peak labor force would be right now. This number bumps up a very small amount, because more people are entering working age than leaving it at the moment. It is at 7.2%
This labor slack number is closer to an apples to apples employment rate than the headline Unemployment number. The "Unemployment Rate" as the bls calculates it, is about setting interest rates. An unemployment rate of 5% is not good news in this context. It means the economy is close to being as good as it is going to get, and the Federal Reserve should have interest rates at neutral.
Let me repeat that low unemployment is not good news because interest rates are now "accomodative". That's fedspeak for "Alan Greenspan is easy". If the unemployment rate is low, then he has to raise interest rates.
Now let's recap. What the official statistics say is that interest rates are too low and have to go higher. What the official statistics say is that while the cost of goods isn't going up - the cost of assets are. Since the official economic policy is to sell assets abroad to buy oil, asset inflation is "good". The official statistics are worried because real wages, even in this context, are going up.
What the measurements I've just given tell you is
- Real inflation paid by real people is moderately high.
- Since wages are nowhere near keeping pace, real wages are dropping.
- Real unemployment - that is the kind you and I feel, rather than the kind Greenspan feels - is also reasonably high historically. (Check out the graph).
- Historically speaking an inflation rate of 5.8% and an unemployment rate of 7.2% is a crisis that calls for drastic government action.
- That's why Bush is unpopular.
Applying the same logic to GDP, one finds something interesting - while CPI is raging, GDP inflation is far more subdued, asset inflation in the economy as a whole tamer. But it is still worse than we are being told. If GDP inflation is higher than we are told, then the GDP numbers being promoted as a sign of a "good" economy are not there.
Under normal circumstances, this would be called what it is: stagflation.
The Death of the Friedman-Mundell Economy
But wait there's more. (Of course there's more, that's what more means) Housing inflation is heavily weighted to the two coasts. Again checking the same numbers as before - only for the coastal areas, one finds that housing inflation isn't adding about 2.6% to places like New York - but closer to 5.5% This means that if you live in the bicoastal areas, inflation doesn't feel bad, it feels blood awful.
In short, one of the reasons that Bush is getting a lot less popular in places that didn't like him before - is because the burden of the Bushconomy's inflation is striking disproportionately in areas that voted against him, twice.
What is important to remember is that economic statistics measure two different things: one is how people feel about the economy, and the other is the policy levers that people in power have to move the economy. "Good" economic numbers mean that policy makers don't have many levers to move - because things are as good as they are going to get.
The divergence between how people feel about an economy and the economic numbers means something bigger than "Bush is bad for bicoastal America". It means that the entire policy regime that has run the US over the last quarter century is falling apart. "Good" economic numbers no longer correspond to the country feeling "good" about the leadership. In a Democracy, when people don't feel good about the leadership - even if the economy is "working", they vote for someone else.
In econospeak terms we are talking about a policy regime a set of indicators and levers of policy that will move the economy towards a state of people being happier. If the levers aren't working - if the numbers say that times are good, and people feel that times aren't so good - it means that the fundamental purpose of the current policy regime is failing.
When the world as government statistics paint it, and the world as people see it diverge there is a large political change ahead. The very way we make decisions is about to change.
War Boom to Peace Bust
What looking at real economic statistics says is that the US has been hovering above recession for over a year now. What is propping up the economy is a huge binge of spending - both war time spending such as the Iraq war and its associated costs, tax reductions that pump money into the economy, and huge pork bills like the transportation bill, the agriculture bill, the perscription drug benefit and the new energy bil.
In short, Bush is attempting to take America down the same road that Japan took in the wake of their 1987 crash: build a bubble in housing prices to keep the ruling party in power, and then use huge public spending injections, and geographic gerrymandering, to prevent the economy from completely meltingdown. Japan has had a series of recessions, and its government has just collapsed again.
The problem is that no one else could do that much better. You see, the divergence between the real world and the government statistical world, creates a policy bind. The Fed can only do one thing at once. The fed is in a policy bind when it has to do opposite things. The last major policy bind was in 1998. Greenspan had to raise interest rates to cut off the stock bubble, and he had to lower them to deal with the world currency crisis. A better policy regime would have realized that two were the same problem - too much money flowing into the US - and done one thing to fix both. But the FM economy couldn't fix that problem. So Greenspan made a choice - he let the US bubble run, and bailedout the world with dollars.
The present policy bind can be seen in how economists are very divided on interest rates. Some are demanding higher rates now others want lower rates. What is interesting is that this isn't a left/right divide. People calling for lower rates run from Nathan Newman to Jude Wanninski. People calling for higher rates run from Stephen Roach to Nouriel Roubini.
The bind is this - the housing bubble demands higher rates to cut it off. But the bad employment situation demands yet lower rates. These two problems are connected - the run away price of housing is based on low interest rates, as is the spiralling price of oil - the world economy is, in fact, overheating. But it is also not producing enough new jobs to keep employed the major world economies, and bring the people in the industrializing and mechanizing economies.
This is really one problem - but the current policy regime can't address it - its own measurements say that it can't. All that it can do is keep pumping up corporate profits, and hope at some point that ignites some way out of this bottleneck.
The Bottom Line
The bottom line is that the old policy regime that has ruled since Reagan is faced with a crisis. That crisis is that while the economy is doing as well as it can do in its current form - as evidenced by "good" economic numbers - that economy is not generating enough activity to keep people happy. Governments are tottering in England, Germany, France, the UK, Italy, Canada and Japan - that is to say 7 of the G-8 - while there are job riots in China and India.
The economic statistics that show why people are unhappy - the inflation number with housing thrown in, the employment slack number, the GDP deflator with housing costs correctly calculated - show an economy in stagflation, propped up by massive borrow and squander policies.
For the time being corporate profits are going to continue to do well, and so will the stock market. If you can work - work. If you can invest - invest. But realize that, as in 1999, the economy is in real trouble, and while the shining top will do well, more and more of the rest of the economy is treading water.
Related: Jerome summarized the case for a housing bubble.
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