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   Brian Wesbury
Chief Economist
 
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   Bob Stein
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  Let’s Finally Fix the CBO
Posted Under: Government • Monday Morning Outlook • Spending • Taxes
If they came back today, the Founders of the United States wouldn’t recognize the government they created 225 years ago. They put safeguards in place – separation of powers, a bicameral legislature and reserved powers for the states – to prevent it from growing so large.

Yet, non-defense federal government spending is now 17% of GDP, triple its size in 1954, and will be headed much higher if we don’t reform entitlements. The U.S. is looking more like Europe – something the Founders wanted to avoid.

Many economists and politicians argue the American Dream is gone. They reminisce about the heyday of America in the 1950s and 1960s when the middle class was strong. Their proposals for returning to that supposed nirvana include more government spending and redistribution.

But this version of the 1950s and 1960s, that government made things fair, is a fiction. During the ten years ending in 1959, non-defense federal spending was just 7% of GDP. And during the 1960s, this measure averaged only 9.6% of GDP.

In other words, if you really want to get back to the 1960s, you would argue for less government spending, not more.

But government has a built in problem – what some have called the “Deep State.” To us, this means an entrenched bureaucracy, educated in Keynesian ideology with a big government mindset that constantly pushes for more government solutions, spending and regulation, while attacking those who oppose it. This is why one of our favorite jokes about Washington rings true: “It Doesn’t Matter Who You Vote For, The Government Always Wins.”

Exhibit A is the Congressional Budget Office (CBO). Uniformly, people call it “The Non-Partisan Congressional Budget Office.” While it is true that the CBO uses economic models that are “politically” non-partisan, it is also true that the models it uses favor more spending and higher taxation. They assume government spending boosts economic growth and see few negative economic effects from tax hikes. These models, the people who defend them and the politicians that allow them to be used consistently bias policy toward a bigger government, with less faith in the private sector.

Win or lose, regardless of whom the voters elect, the unelected bureaucracy keeps marching towards a larger, more intrusive government. Partly this occurs because elected officials buckle under the weight of the data produced by the models and complicated analysis that surrounds them, even if it is erroneous. It takes active awareness and a willingness to fight to defend against this. This is especially true after a crisis that gets blamed on the private sector, like The Panic of 2008.

It’s with this in mind that we urge the new Congress to replace the Director of the CBO, Doug Elmendorf. By all accounts, Mr. Elmendorf is a competent and smart man with solid credentials. But the CBO needs to junk their static and Keynesian worldview and start using more dynamic scoring. Changing tax rates can not only shift the time and place of economic activity, which the CBO thankfully includes in its model. But, what the CBO does not account for, is the fact that these changes affect the total amount of activity, as well.

In addition, it is now clear that the CBO, and its models, were manipulated by the White House to pass the Affordable Care Act. It’s also clear that many knew about this. It was the Deep State in action. And, it’s clear only new leadership can change that. If the GOP will not appoint people who are actively aware of the Deep State and are willing to fight it, it will lose the major policy battles even if it wins at the polls.

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Posted on Monday, November 24, 2014 @ 9:47 AM • Post Link Share: 
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  Existing Home Sales Rose 1.5% in October to a 5.26 Million Annual Rate
Posted Under: Data Watch • Home Starts • Housing

 
Implications: Forget about home sales for a minute. On the manufacturing front, the Philly Fed index, a measure of factory sentiment in that region, rose to +40.8 in November from +20.7 in October, blowing away all consensus expectations and hitting the highest level since 1993. We’ll see how the data for the whole month turn out now that winter weather has started unusually early, but it looks like manufacturing had lots of momentum just before the recent polar plunge. On the housing front, existing home sales look like they’re keeping their recent mojo. Sales increased 1.5% in October, have risen in six of the last seven months, and are now the highest in over a year. Overall sales are up a modest 2.5% from a year ago. However, distressed homes (foreclosures and short sales) now account for only 9% of sales, down from 14% a year ago, while all-cash buyers are now 27% of sales versus 31% a year ago. As a result, non-cash sales (where the buyer uses a mortgage loan) are up 8.5% since last October. So, even though tight credit continues to suppress sales, we are seeing signs of an easing in mortgage credit, which suggests overall sales will continue to climb in the year ahead. Another reason for the tepid recovery so far in existing home sales is a lack of inventory. Inventories are up 5.2% from a year ago, but down over the past three months. In the year ahead, we expect higher home prices to bring more homes on the market, which should help generate additional sales. Either way, whether existing home sales are up or down, it’s important to remember these data, by themselves, should not change anyone’s impression about the overall economy. Existing home sales contribute almost zero to GDP. Look for better sales in the months ahead. But, unless lenders dramatically loosen standards, the increases in sales will remain tame by historical standards.

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Posted on Thursday, November 20, 2014 @ 12:34 PM • Post Link Share: 
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  The Consumer Price Index (CPI) was Unchanged in October
Posted Under: CPI • Data Watch

 
Implications: Next time you see an energy engineer, remember to give them a hug. They deserve it. Energy prices fell for a fourth straight month in October and continue to mute rising prices elsewhere for consumers. Consumer prices are up a modest 1.7% in the past year and the key reasons is America’s booming energy production and, as a result, lower world oil prices. The gasoline index is down 5% in the past year and now stands at the lowest level since February 2011. Given the continued drop in oil prices in the first half of November, look for another tame reading on overall price gains in next month’s report. However, there are sectors where inflation is moving higher. Food and beverage prices are up at a 3.1% annual rate in the past six months and up 2.9% in the past year. So if you only use the supermarket to gauge inflation, we understand thinking the headline reports are too low and that “true” inflation is higher. In addition, housing costs are going up. Owners’ equivalent rent, which makes up about ¼ of the overall CPI, rose 0.2% in October, is up 2.7% in the past year, and will be a key source of any acceleration in inflation in the year ahead. One of the best pieces of news in today’s report was that “real” (inflation-adjusted) average hourly earnings rose 0.1% in October. These earnings are up 0.4% from a year ago and workers are also adding to their purchasing power because of more jobs and more hours worked. Plugging today’s CPI data into our models suggests the Fed’s preferred measure of inflation, the PCE deflator, was probably unchanged in October. If so, it would be up 1.4% from a year ago, still below the Fed’s target of 2%. We expect this measure to eventually hit and cross the 2% target, but given the bonanza from fracking and horizontal drilling, not until next year. In other news this morning, new claims for unemployment insurance declined 2,000 last week to 291,000. Continuing claims fell 73,000 to 2.33 million, a new low for the recovery. Plugging these figures into our employment models suggests nonfarm payrolls are growing 200,000 in November, with private payrolls up 191,000.

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Posted on Thursday, November 20, 2014 @ 12:18 PM • Post Link Share: 
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  Housing Starts Declined 2.8% in October
Posted Under: Data Watch • Home Starts • Housing

 
Implications: Home building has been very volatile over the past few months but the underlying trend remains upward and we expect that to continue. The best news from today’s report was that building permits rose 4.8% in October, as single-family and multi-family permits rose 1.4% and 10% respectively. Permits now stand at the highest level since June 2008, signaling future gains in home building in the months to come. October’s drop of 2.8% for home building was all due to multi-family units, which were down 15.4% in October and have caused large swings in overall housing starts over the past few months. Single-family starts have been steadily rising over the past three months. So, the multi-family volatility over the past few months has masked slow underlying improvement in the housing sector. To smooth out the volatility we look at the 12-month moving average. This is now at the highest level since September 2008. The total number of homes under construction, (started, but not yet finished) increased 1.4% in October and are up 20.1% versus a year ago. No wonder residential construction jobs are up 131,000 in the past year. Although multi-family construction has slowed over the past few months, it has still taken the clear lead in the housing recovery. Single-family starts have been in a tight range for the past two years, while the trend in multi-family units has been up steeply. In the past year, 36% of all housing starts have been for multi-unit buildings, the most since the mid-1980s, when the last wave of Baby Boomers was leaving college. From a direct GDP perspective, the construction of multi-family homes adds less, per unit, to the economy than single-family homes. However, home building is still a positive for real GDP growth and we expect that trend to continue. Based on population growth and “scrappage,” housing starts will rise to about 1.5 million units per year over the next couple of years.

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Posted on Wednesday, November 19, 2014 @ 10:07 AM • Post Link Share: 
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  The Producer Price Index Rose 0.2% in October
Posted Under: Data Watch • PPI

 
Implications: Producer prices surprised to the upside in October versus consensus expectations for a slight decline due to falling energy prices. The gain in overall producer prices was all due to the services sector, where prices rose 0.5%. Oddly, about half of the gain in service prices was due to refiners generating fatter margins while the energy prices fell. In other words, the drop in energy prices did not get fully passed on to users. Meanwhile, it’s the same old story for prices of energy goods, which fell 3% in October and are down 3.7% in the past year, a testament to fracking and horizontal drilling. Overall, today’s report is consistent with our forecast that the US isn’t going to suffer either hyperinflation or deflation. Instead, it’s going to be a slow slog upward for inflation. Prices further back in the production pipeline (intermediate demand) show that it will take a while for inflation to move up high enough for the Federal Reserve to take notice. Prices for intermediate processed goods are up only 0.4% in the past year and unprocessed goods are down 2% in the past year. Regardless, with the labor market improving more rapidly now that extended unemployment benefits are done, the Fed is still on track to start raising rates around the middle of next year. These rate hikes will not hurt the economy; monetary policy will still be loose. The problems that ail the economy are fiscal and regulatory in nature, which can’t be addressed by the Fed. In other news this morning, the NAHB index, which measures confidence among home builders, rose to 58 in November from 54 in October, with largest gain for current single-family sales. The housing recovery remains on track.

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Posted on Tuesday, November 18, 2014 @ 12:17 PM • Post Link Share: 
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  M2 and C&I Loan Growth
Posted Under: Government • Fed Reserve

 
 
Posted on Tuesday, November 18, 2014 @ 7:49 AM • Post Link Share: 
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  Deflation Fears Are A Distraction
Posted Under: Europe • Government • Monday Morning Outlook • Fed Reserve • Interest Rates
No matter what happens these days, deep fears, driven by breathless newscasters, take things to the extreme. As a result, slight gains in inflation create forecasts of “hyper-inflation,” while slowing or low inflation leads to fears of “deflation.”

As we predicted, hyper-inflation never occurred, so, let’s make another forecast – deflationary fears are overblown, too. The world is highly unlikely to have a deflationary spiral, where the “real” (inflation-adjusted) value of debts would increase, leading to destabilizing defaults, with “sticky” wages leading to much higher unemployment. This would be a deflationary recession, or depression, which, for the record, is so rare it could be labeled a Black Swan.

One thing driving these forecasts is falling oil prices, but oil prices are dropping because of increased supply (thank fracking). Therefore, any slow or falling inflation due to oil is a supply-side, or “good” type of deflation.

Some of those worried about deflation are the same forecasters who predicted that Quantitative Easing would cause hyper-inflation. But it’s M2 – all deposits in all banks – that drives inflation and deflation, not a Central Bank balance sheet. In the U.S. the M2 measure of money is rising at roughly a 6% annual rate. Overall spending (nominal GDP – real GDP growth plus inflation) is rising at close to a 4% annual rate. There is absolutely no sign of monetary deflation.

And even when short-rates eventually move up next year, they’ll still be low relative to key economic fundamentals. The Fed will be less loose, but not tight; not deflationary.

It is certainly possible that some broad price measures may move down temporarily due to lower energy prices. For example, we are forecasting that consumer prices slipped 0.1% in October. But they will still be up 1.5% from a year ago and, as we already said, this is a supply-induced dip in inflation.

Fears of Eurozone deflation seem more realistic, with consumer prices up a scant 0.4% in the past year. But Eurozone M2 is up 3% in the past year even though the European Central Bank has yet to commit to Federal Reserve-style Quantitative Easing.

Also, it’s important to recognize that a zero change in prices is not a magical number, on one side of which everything is OK, but the other side of which means doom.

Population growth in Europe (and Japan) is weak, which is holding down nominal GDP growth. Meanwhile, bloated governments are holding down overall real growth while productivity growth in the private sector is keeping a lid on inflation. In this environment, using monetary policy to artificially boost nominal growth is going to just push up inflation, not boost real growth, job creation, wages, or living standards.

Fears about deflation are a distraction in Europe, which needs supply-side fiscal and regulatory reforms that would increase potential economic growth and make the current stance of monetary policy looser without having to resort to gimmicks like quantitative easing.

The same goes for Japan. The Bank of Japan is boosting the size of its balance sheet, but its economy is contracting. “Abe-nomics” – easy money, higher taxes and more government spending – is a Keynesian wish-list of failed ideas which cannot possibly boost growth.

The bottom line: fears of hyper-inflation or deflation are a distraction from the real problem of bad government policy.

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Posted on Monday, November 17, 2014 @ 10:40 AM • Post Link Share: 
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  Industrial Production Declined 0.1% in October
Posted Under: Data Watch • Industrial Production - Cap Utilization

 
Implications: Please feel free to ignore the headline decline in industrial production in October. Despite a slowdown in some of the rest of the world, the sky is not falling on the US economy. The 0.1% decline in output in October was driven by the most volatile parts of the report – utilities, mining, and auto production – all of which were down. Stripping out these three volatile sectors and only looking at manufacturing outside of autos, production was up a Plow Horse 0.3% in October and is up 3.3% versus a year ago. In the past 15 months, this key measure has only declined once, and that was last January during the worst of the unusually brutal winter. We expect continued growth in the industrial sector in the year ahead. The housing recovery is still young and both businesses and consumers are in a financial position to ramp up investment and the consumption of big-ticket items, like appliances. Despite a drop in October, capacity utilization still stands at 78.9%, right at the average over the past twenty years. Further gains in production in the year ahead will push capacity use higher, which means companies will have an increasing incentive to build out plants and equipment. In other news this morning, the Empire State index, a measure of manufacturing sentiment in New York, rose to 10.2 in November versus 6.2 in October. The bottom line is that the trend in the industrial sector is up, not down, and we expect the top-line of the report to show a solid rebound next month.

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Posted on Monday, November 17, 2014 @ 10:20 AM • Post Link Share: 
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  Retail Sales Increased 0.3% in October
Posted Under: Data Watch • Retail Sales

 
Implications: Retail sales rebounded in October after a temporary dip in September. Although sales increased a pedestrian 0.3%, what makes this so impressive is that, due to plummeting oil prices, sales at gas stations dropped 1.5%. Gas prices are down 7.6% from a year ago and may continue to be a good headwind for total retail sales. Largely due to horizontal drilling and fracking, US oil production just crossed 9 million barrels a day, the most since 1986. The reason we call it a good headwind is that lower gas prices will hold down overall inflation even as consumers take the money they save on gas and buy other items, so “real” (inflation-adjusted) consumer spending will not be affected. Today’s report shows signs of that shift. “Core” sales, which exclude autos, building materials and gas, increased 0.6% in October and 0.8% including upward revisions to August and September. These sales, which are a key input into GDP calculations, are up nine months in a row. If unchanged in November and December, core sales would still be up 3.5% at an annual rate in Q4 versus Q3. We expect consumer spending to accelerate in the year ahead, as lower unemployment means an acceleration in income gains at the same time consumer debt service is hovering near multiple-decade lows. In other news this morning, still no sign of inflation in the trade sector. Import prices fell 1.3% in October, although they declined only 0.1% excluding petroleum. Export prices fell 1% in October. In the past year, import prices are down 1.8% while export prices are down 0.8%. In other recent news, new claims for jobless benefits rose 12,000 last week to 290,000. Continuing claims for regular state benefits increased 36,000 to 2.39 million. Despite these increases, our models still show solid payroll growth of around 195,000 in November. The economy came into 2014 as a Plow Horse and looks like it’ll be leaving it a Plow Horse as well.

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Posted on Friday, November 14, 2014 @ 10:03 AM • Post Link Share: 
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  Change Is In The Air
Posted Under: Government • Markets • Monday Morning Outlook • Productivity • Bonds • Stocks
While many flail away, trying to figure out the meaning of last week’s GOP wave election, it seems simple. The government has tried for more than five years to turn a Plow Horse economy into a Race Horse, and failed. Yes, the economy is growing and creating jobs, but living standards are growing slowly, or not at all, for many.

This doesn’t mean Republicans gave voters a reason to vote for them. There was no clear national agenda broadly accepted by GOP candidates going into the election.

Instead, the GOP capitalized on disappointment with President Obama, the economy, and a general feeling of malaise. Like the 1970s, a large expansion of the entitlement state, higher tax rates, a patchwork quilt of crony capitalism, including subsidies for wind and solar power and electric cars has undermined growth. And no amount of Federal Reserve quantitative easing seems to help – banks are just piling up excess reserves.

What’s interesting is that voters seem to get what many opinion-leaders don’t get at all. There is an eerie agreement between many on the left and right that QE has had a big effect. The “left” – led by Paul Krugman – says QE (and other government spending) kept rates down, boosted stocks, increased consumer wealth and demand, and, therefore, economic growth. We just needed more of everything.

Meanwhile, many on the “right” say the only reason stocks are up is because of QE, but that somehow it only affected stocks and nothing else. They say this because they don’t want President Obama to get credit for anything.

We’re not sure which side is more twisted up in intellectual knots. If QE kept interest rates down, why did rates fall as the Fed tapered and then ended QE? And if QE is the main reason stocks are up, why hasn’t QE generated higher gold prices, a lower dollar, or broad-based inflation?

The bottom line is that neither Ben Bernanke nor Janet Yellen have ever fracked a well or burned the midnight oil writing apps. This recovery has not been about Washington, DC at all. It’s been about the Cloud, and 3D printing, and surging energy production, as well as, yes, a natural normal recovery in home building and auto production, which would have been even stronger if the federal government had just left those sectors alone.

That’s why profits are up and, in turn, profits are the key reason the stock market has been in a bull run. Meanwhile, those profits are helping generate the recovery we have, despite all the harmful policy gimmicks of the past decade.

In the end, the voters are looking for results and the only mechanism that will give them the extra growth they want is freer markets, including the freedom to fail.

Last week gave us two reasons to hope this policy shift is on the way. One is that many (but by no means all!) in the GOP are inclined to support freer markets and now their political hand is stronger. The other was the news Friday that the Supreme Court agreed to review a challenge to the health care law that asks whether Obamacare can only provide subsidies in states that run their own exchanges.

It’s hard to exaggerate the significance of this legal case. If the Court rules against the Obama Administration’s interpretation of the law – and we think it probably will – it would, in effect, free each state to decide whether it will be an Obamacare state or not as written. Without all the states involved, we doubt the law can survive. Those who support freer markets would be poised to move the health system in that direction.

None of this can be taken to the bank. Politicians, that supposedly support freer markets, have squandered the Reagan-Thatcher revolution – just look at 2005-06, when the GOP controlled every elected branch of government. But this time, the American public is running out of options. Freer markets are the only thing left to try. The stock market seems to understand this and is moving higher.

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Posted on Monday, November 10, 2014 @ 9:10 AM • Post Link Share: 
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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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