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Brian Wesbury
Chief Economist
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Bob Stein
Deputy Chief Economist
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 | The White House on Building a Strong Economy — Grade: D+ |
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| Posted Under: Government • Press |
The Administration has taken up the mantle of growth. In a speech on June 14 in Cleveland, OH, the President said:
"And what's lacking is not the capacity to meet our challenges. What is lacking is our politics. And that's something entirely within your power to solve. So this November, you can remind the world how a strong economy is built — not from the top down, but from a growing, thriving middle class."
Capitalism is an organic, natural process that utilizes prices to send signals. When a capitalist system is allowed to function properly (freely), it generates cooperation, specialization, and service towards others. Every part (bottom, middle, and top) works together to lift living standards. But the key to creating wealth is the entrepreneur. Entrepreneurs tirelessly look for the best, most efficient, most profitable ways to allocate resources. Those who do this well accumulate more resources; those who fail lose resources.
The very nature of this process creates people at the "top" — those who earn profits from their efforts. To demonize these people is the antithesis of capitalism. Trying to level the playing field by regulating, taxing, or otherwise thwarting their efforts harms the entire system, which in turn hurts those in the middle and at the bottom. The idea that an entrepreneur only helps herself is a false idea. Entrepreneurs profit by providing goods and services that other people value.
Losing sight of this process — and pitting the middle class against the entrepreneur — is political. Moreover, if followed through to its conclusion, it would actually harm growth and therefore the middle class itself.
Click here to read my entire piece at the 4% Growth Project.
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| | Existing home sales fell 1.5% in May, sales up 9.6% from a year ago |
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| Posted Under: Data Watch • Home Sales • Housing |
Implications: The housing recovery continues. Although existing home sales fell 1.5% in May, sales are still up 9.6% from a year ago. The median price of an existing home is up 7.9% from a year ago, the largest yearly gain since 2006 and the third consecutive month of year-to-year gains. Price gains were, at least in part, due to fewer distressed sales and more sales of larger homes, a good sign for the economy moving forward. It still remains tough to buy a home. Despite record low mortgage rates, home buyers still face very tight credit conditions. Tight credit conditions would also explain why all-cash transactions accounted for 28 percent of purchases in May versus a traditional share of about 10 percent. Those with cash are able to take advantage of home prices that are extremely low relative to fundamentals (such as rents and replacement costs); for them, it's a great time to buy. With credit conditions remaining tight, we don't expect a huge increase in home sales any time soon, but the housing market is definitely on the mend. In other housing news this morning, the FHFA index, a price measure for homes financed by conforming mortgages, was up 0.8% in April (seasonally-adjusted). Prices are up 2.4% in the past two months alone. This is the fastest 2-month gain anytime on record, going back to 1991, even including the housing boom! Today's news on manufacturing was not as good. The Philadelphia Fed index fell to -16.6 in June from -5.8 in May. Some view this dip as a recession sign, but the Philly Fed Index fell to -20 in August 2011 and the Plow Horse Economy's real GDP still grew at a 1.8% annual rate in that quarter, so it does not mean we're in a recession. More likely, the report reflects concerns about Europe, rather than actual changes in activity. Meanwhile, new claims for unemployment insurance dipped 2,000 last week to 387,000 while continuing claims were unchanged at 3.30 million. These figures suggest tepid payroll growth in June: 45,000 nonfarm and 55,000 private. We think some firms are waiting for the health care ruling to decide how many workers to hire.
Click here for a PDF version.
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| | Fed Does the Least |
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| Posted Under: Government • Inflation • Research Reports • Fed Reserve • Interest Rates |
In the past few days, news outlets have breathlessly reported that the Federal Reserve would today launch into another round of quantitative easing, probably including major purchases of mortgage backed securities. Instead, the Fed did the least that was expected, extending Operation Twist until the end of the year, but not altering the size of its balance sheet at all and not – as some analysts suggested it might – changing when it thinks it will start raising rates (still late 2014).
Operation Twist was originally implemented last September and has the Fed selling short-term Treasury securities and using the proceeds to buy long-term Treasury securities. We don't think this program makes a dime's worth of difference for the economy. In the end, it's really an act of fiscal policy, not monetary policy, no different than if the US Treasury Department financed the federal debt by issuing more short-term debt and issuing less long-term debt. (By the way, given very low long-term interest rates, this would be an awful idea.)
Compared to the last statement from April 25, the Fed did make some changes to its language, all in the dovish direction. The Fed said "growth in employment has slowed," "household spending appears to be rising at a somewhat slower pace," and unemployment looks likely to decline "slowly," rather than "gradually." It also said inflation "has declined."
In addition, the Fed made it clear that it "is prepared to take further action" if either the situation in Europe deteriorates or the labor market fails to improve.
These changes are consistent with the new economic and interest rate forecast from the Fed. The Fed now projects real GDP growth of 1.9% to 2.4% in 2012, a downgrade from April, when the range was 2.4% to 2.9%. The Fed also reduced its estimate for growth in 2013, to roughly 2.5%, and projects unemployment will still be 7.5% to 8% at the end of 2013. Previously, the Fed was more confident the jobless rate would be down to 7.5% by that point in time. The Fed also slightly reduced its estimate of inflation for 2012.
While the Fed still projects near zero short-term interest rates through the end of 2014, the median forecast among members of the Federal Open Market Committee is that the funds rate will end 2014 at 0.5%, not the 1% previously forecast. In addition, the range for the federal funds rate over the long term fell slightly. It's now 3% to 4.5%, but used to be 3.5% to 4.5%.
Once again, the lone dissent from the Fed's statement was from Richmond Fed President Jeffrey Lacker, who opposed the extension of Operation Twist.
Click here for a PDF version.
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| | Housing starts up 28.5% versus a year ago. The recovery in home building is clearly underway |
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| Posted Under: Bullish • Data Watch • Home Starts |
Implications: The recovery in home building is clearly underway. Although housing starts fell 4.8% in May, all the decline was due to multi-family starts, which are very volatile from month to month, but still up substantially from a year ago (see chart to right). Single-family starts increased 3.2 percent in May and are up 26.2 percent from a year ago. In addition, the apparent decline in May was in part due to last month's starts getting revised up to a 744,000 annual rate, the best number since October 2008. Looking deeper into the report, the total number of homes under construction (started, but not yet finished) increased for the ninth straight month, the first time this has happened since 2003-2004. Permits to build homes boomed in May, coming in at a 780,000 annual rate, the highest since September 2008. Permits are now up 25% from a year ago. Single-family permits rose 4% in May and are at the highest levels since early 2010, signaling continued gains in home building in the coming year. It looks like the second quarter of 2012 will be the fifth straight quarter where home building boosts real GDP. Based on population growth and "scrappage," housing starts should eventually rise to about 1.5 million units per year (probably by 2016), which means the recovery in home building is still very young. For more on the housing market, please see our research report (link). In other recent housing news, the NAHB index, a measure of homebuilder confidence, increased to 29 in June, the highest level in five years.
Click here for a PDF version.
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| | Should Germany Leave the Euro? |
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| Posted Under: Europe • Monday Morning Outlook |
The weekend victory for the center-right keeps the Greek "austerity" plan alive and makes it less likely Greece will try to leave the Euro. It may be difficult to form a broad coalition government, but for the time being, the Greek election raises hope for market friendly reforms.
Initially, stock prices rose sharply as election results arrived. Then, as the different factions began to posture, threaten and negotiate, stocks pulled back. If Greece does not move forward with austerity, talk of it leaving the Euro may increase again. Leaving the Euro would be an unmitigated disaster for Greece and a problem for the Eurozone, but the odds of this happening are priced into the Euro already.
What isn't priced into the Euro is the exit of another country. No, not Spain, Portugal, or Italy. We're talking about the inner-most core of the Euro-zone: Germany.
Back in the 1990s, when the final details of the Euro were worked out, every country had a good reason to join, over and above the obvious one that it made it easier to do business across borders. France had always been jealous of "reserve-currency countries" – one used by other countries as a reserve. The UK, the US, and Germany all had that privilege and it galled the Gauls that France did not. The Euro changed this.
Many of the other countries that joined the Euro, like Italy, Greece, and Spain, got something even more important: good monetary policy. They had proven time and again that their central banks could not maintain low inflation. So why not, in effect, import tough German central bankers to run monetary policy. Germans, after all, often blamed the hyperinflation after World War I as laying the groundwork for the Nazi takeover in the early 1930s. As a result, since World War II, they had kept inflation relatively low.
Germany got something even more important when it joined the Euro: it got the other countries to treat it as a normal country again. No more guilt over WWI or II. Bygones were finally bygones, once and for all.
But now, given the trouble some other Euro-zone countries have gotten themselves into, it looks like the bargain is changing. Germany could find itself on the hook for other countries' debts – on a persistent basis. And, if other countries have their way, the European Central Bank could be used to run an inflationary monetary policy.
In other words, the Germans may be forced to pay higher taxes and accept a debased currency in order to fund profligate social welfare spending schemes in other countries.
So why not just leave the Euro behind and go back to the Deutschemark (DM)? In the end, only a strong currency can replace a weak one. This is why the Drachma is not going to make a comeback...it would fail miserably and do nothing positive. But, for Germany, it is a different story.
If Germany left the Euro and brought back the DM, it would likely soar versus the euro. Without Germany, the Euro would be dominated by countries with a track record of loose money. While a strong DM might hurt some German exporters, the Euro is already strong relative to the dollar and the unemployment rate is only 6.7%. In other words, this is a favorable time to make the move. Meanwhile, imports would cost less and Germany would have less inflation.
German debtors (including the government) who have debt denominated in Euro's would get a windfall gain; they would pay back debt denominated in a weak Euro with a strong DM. At the same time they wouldn't feel as responsible for bailing out profligacy. Life would be good.
France, Italy, Spain, Portugal, and Greece would finally get to run the loose money they all want the ECB to implement anyhow, so they couldn't complain about that. Their real problem is that Germany would no longer subsidize their spendthrift ways.
Most humiliating for the rest of Europe is that the ECB would probably want to buy German debt, denominated in DM as a reserve, while the Germans would have no need to buy the Euro-debt of the other countries to back up the new DM. So while short-sellers and pessimists try to ramp up fear of a "Grexit"...it's a more rational German exit from the Euro that would expose the flaws and irrational behavior of tax and spend government policy. It's way better to deal from a position of strength than from one of weakness.
Click here for a PDF version.
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These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.
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