4th Quarter 2010: Revised Down to 2.8%

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The Fed and Money Expansion

To understand how the receipt of new reserves influences a bank's behavior, the place to start is to ask whether the bank is willing to hold the reserves overnight. Prior to 2008, a bank could earn no interest on reserves, and could get some extra revenue by investing any excess reserves, for example, by lending the reserves overnight to another bank on the federal funds market. In that system, most banks would be actively monitoring reserve inflows and outflows in order to maximize profits. The overall level of excess reserves at the end of each day was pretty small (a tiny sliver in the above diagram), since nobody wanted to be stuck with idle reserves at the end of the day. When the Fed created new reserves in that system, the result was a series of new interbank transactions that eventually ended in the reserves being withdrawn as currency.

All that changed dramatically in the fall of 2008, because (1) the Fed started paying interest on excess reserves, and (2) banks earned practically no interest on safe overnight loans. In the current system, new reserves that the Fed creates just sit there on banks' accounts with the Fed. None of these banks have the slightest desire to make cash withdrawals from these accounts, and the Fed has no intention whatever of trying to print the dollar bills associated with these huge balances in deposits with the Fed.

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$61 Billion Budget Cuts

Talk of a government shutdown is heating up. The current continuing resolution funding the government is set to expire on March 4th. Last week, House Republicans passed a bill that would fund the remainder of fiscal 2011 at $61 billion below fiscal 2010 levels. Senate Democrats are balking at the $61 billion in cuts and the president has issued a veto threat.

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Current Market: S P 500

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CPI and PCE

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CPI Categories

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Federal Taxes

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Composition of Federal Spending

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Federal Payments to Individuals

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Real GDP per Capita

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World GDP per Capita

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Budget Deficits: A Spending Problem

The new Congressional Budget Office (CBO) 10-year budget baseline shows a virtually unprecedented sea of red ink. The report reveals an unprecedented $1.5 trillion deficit in fiscal year (FY) 2011—an increase of $95 billion over their last 2011 estimate.[1] This will be the third consecutive year of trillion-dollar deficits.

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US Manufacturing

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January 2011 Unemployment: 9.0%

The Labor Department reported nonfarm payrolls rose by just 36,000 in January while the unemployment rate fell from 9.4 percent to 9.0 percent, the lowest level since April of 2009.

Though hiring in the manufacturing sector was quite strong, the nonfarm payrolls gain was disappointing, well below the consensus estimate of 140,000.
The drop in the jobless rate was a pleasant surprise was also disappointing as it was due largely to more workers finding jobs leaving the rather than a shrinking labor force. The broader U-6 measure of unemployment, including those who have stopped looking for work and those settling for part-time work, fell from 16.7 percent to 16.1 percent.

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According to the Bureau of Economic Analysis (BEA), real GDP is now slightly above the pre-recession peak. Real GDP (in 2005 dollars) was at $13,382.6 billion in Q4, just 0.14% above the $13,363.5 billion in Q4 2007.

However industrial production is still 5.8% below the pre-recession peak, and it will probably be some time before industrial production returns to pre-recession levels.

Payroll employment is still 5.6% below the pre-recession peak. And even with slightly above trend GDP growth in 2011, payroll employment growth will probably only recover slowly. Payroll employment is still 7.7 million below the pre-recession peak, and if the the U.S. adds 2.5 million payroll jobs per year over the next 3 years (my current forecast is 2.4 million private sector jobs this year), it would take 3+ years to return to the pre-recession peak. And that doesn't include population growth!

This graph shows real personal income less transfer payments as a percent of the previous peak.This has been slow to recover - and is still 4.3% below the previous peak.

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Cartoon: Oil Prices

Cartoon: Needs

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Economic Recovery

In the fourth quarter, economic output reached a $13.38 trillion seasonally adjusted annual rate, measured in 2005 dollars, inching 0.14% above the final quarter of 2007, when the recession began.

In the summer of 2009, the recession's official end, output plunged 4.14% below pre-crisis levels to a $12.81 trillion seasonally adjusted annual rate.

It took 12 quarters to recoup the losses and, on a per-capita basis, the economy is still not as large as it was before the recession took hold. Such a prolonged recovery is unusual: It took eight quarters to bounce back from the deep recession of the early 1970s.

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Real GDP Now Above Pre-Recession Level

"U.S. economic output finally regained the level reached before the recession, as growth sped up on stronger consumer spending and exports (see chart above).

Gross domestic product—a broad measure of all goods and services produced—grew at a 3.2% annual rate in the fourth quarter. That's up from the 2.6% pace notched the quarter before and confirms the view held by many economists and stock-market investors that the economy is gaining enough momentum to start bringing down unemployment in the months ahead.

The expansion in large part was fueled by a jump in consumer spending—a crucial change from earlier in the recovery, when growth relied heavily on businesses investing and building up inventories. Final sales—a measure that gives a feeling for underlying demand in the economy by subtracting the change in business inventories from GDP—notched its biggest increase since 1984, growing 7.1% in the fourth quarter. This reviving demand bodes well for 2011, because businesses could take it as a signal to stock their shelves and hire workers."

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