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The Pulse of Capitalism

Issue Number 04-2, July 2004

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International Comparisons
Business Activity Indicators
Financial Indicators - United States
Selected International Transactions - United States

The Present Economy

At this time we do not know whether the economic downturn that began in 2000 has ended or is still ongoing. Data for one or two quarters can easily be misleading and not indicate the beginning of a new trend, as has been shown repeatedly in Japan over the past decade.

The causes of downturns are at best difficult to identify. In retrospect, the causes of the 1990-91 recession were related to the financial stresses in the savings and loan industry and in commercial banks that depressed bank lending for a time. But these stresses, in turn, were related to interest rate gyrations in the 1980s. The greatest downturn of them all - the 1930s - is still debated by observers with no consensus as to the basic causes.

The stakes on the direction of the economy at this time are unusually high. In their attempt to stop and reverse the downturn, the political and monetary leadership have thrown virtually all of their resources into the battle. These include direct tax rebates and tax rate reductions for individuals, tax rate reductions and 50 percent write off of current investment expenditures for corporations, and 50-year low short term interest rates. In addition there has been a $600 billion swing in the federal government fiscal position from surplus to deficit in the past three years. If these actions fail to ignite a new upturn, we are faced with greater economic turmoil than anything since the 1930s.

Monitoring the current situation thus becomes even more important than it has been in recent years. To do this we propose to look at the average yearly change in a series of indicators during three different periods: first the economic boom from 1992 to 2000, second the two years of downturn 2001-2002, and third, the recovery period 2003-Q1, 2004. The data for the 1992-2000 period represent the yearly increase in economic activity needed to maintain prosperity and avoid increasing unemployment. It will thus serve as an objective measure of whether the current all-out gamble to re-inflate the economy will succeed.


Average Yearly Change (chained [20000] dollars)
1992-2000 2000-2002 2003 Q1 2004
Personal consumption expenditures 225.6 200.5 221.8 193.4
Gross private domestic investment 105.8 -81.8 63.7 109.0
Gov't consump. Expend's & investment 20.8 57.7 62.6 20.8
Source: Survey of Current Business, Feb. 2004, Table 2A

Personal consumption expenditures, the largest component of GDP, declined moderately in 2001-2 but rebounded in 2003. This rebound was not reinforced in the first quarter of 2004 despite the tax and credit stimulants previously mentioned. Gross investment fell drastically in 2001-2 before recovering in 2003 and FQ 04. The strongest segment has been I.P. equipment and software. Government consumption and investment accelerated in the downturn years of 2001-2 and also in 2003; the increases were primarily in defense expenditures but did not continue in FQ 04.


Average Yearly Change
1992-2000 2000-2002 2003 Q1 2004
Disposable personal income ($bns) 304.9 331.6 359.3 310.6
Corporate profits with i.v.a. ($bns) 38.8 -8.3 101.1 42.7
Source: Survey of Current Business

Disposable personal income increased all through the period 1992-2003. However, personal taxes (which are deducted from personal income to equal dis- posable personal income)rose $75.0 bn per year during the 1992-2000 period but rose only $8.0 bn in 2001 and fell $190.6 in 2002 and $61.7 bn in 2003. If the tax level for 2001 had been maintained, the yearly increase in disposable personal income for 2000-2002 would have been $236.3 bn instead of the $331.6 bn shown in the above table, and the yearly increase for 2003 would have been $297.7 bn instead of $359.3 bn. In short, the continued growth in disposable personal income was maintained as much by tax cuts as by increases in personal income. Preliminary data for FQ 2004 show a gain of $310.6 bn as tax deductions stabilized. Adjusted for tax changes disposable income has risen markedly less from 2000-FQ 2004 than in the nineties.

Corporate profits with inventory valuation but not capital consumption adjust-ments fell in 2000 and 2001 before rising again in 2002 and 2003. The downturn in 2000 and 2001 can probably be explained by two factors. First, industrial production fell from an index of 115.4 in 2000 to 110.9 in 2002, after yearly gains from 1992-2000. Second, many companies that had been profitable incurred losses in the wake of the technology bust (example: Lucent Technologies).

The strong upturn in corporate profits in 2003 is perhaps more intriguing. The following data may shed light on it:

2001 2003
Index of industrial production (1997 =100) 111.5 111.1
Employment in goods production (thousands) 23,873 21,817
Capacity utilization rate - all industries 77.4 74.8
Corporate profits - non-financial ($bns) 318.8 410.0
(Economic Indicators)

These data show that industrial production was almost as high in 2003 as in 2001, but it was achieved with 2.0 million fewer workers; the saving in labor costs then fed through to higher profits. This is the other side of "improved productivity".

The rise of profits in the first quarter of 2004 (a.r.) did not match that of 2003 but was still higher than the yearly average in the nineties.


Average Yearly Change
1992-2000 2000-2002 2003 Q1 2004
Non-financial ($bns) 791.8 1,254.9 1,719.2 481.8 (3 mos.)
   Federal ($bns) 38.1 126.0 396.1 116.5 (3 mos.)
   Household ($bns) 385.9 710.6 903.1 252.0 (3 mos.)
   Financial ($bns) 673.0 922.0 1,044.7 201.4 (3 mos.)
(FRB Flow of Funds)

As these figures show, frugality is no longer part of the national vocabulary. We have been addicted to debt for decades. In 1980 non-financial debt was equal to 162.3 percent of national income; by 2003 it had risen to 230.7 percent. Debt growth has helped stimulate the economy throughout this period, so, like any addict, when things changed adversely in 2000, we increased the dosage.

Non-financial debt growth increased from $791.8 bn per year in the nineties to $1,719.2 bn in 2003; the Federal sector accounted for $358.0 bn of this increase. Federal debt growth was restrained in the nineties by budget surpluses from 1998 to 2001, but then exploded as tax cuts reduced income and expenditures accelerated. Another $517.2 bn of the increase was accounted for by the household sector, with a 100 percent higher increase from 2000-2003 than in the nineties. The major part of this increase was in home mortgages, stimulated by record low interest rates. Consumer credit was also important, responding to unprecedented no-down payment and low interest rate offers by sellers. In 1980, household debt equaled 69.4 percent of disposable personal income; by 2003 it had risen to 114.5 percent. As this percentage rises, more and more households face financial disaster if their incomes falter or disappear. The growth of this danger can be graphed as follows:

How high can a little bird fly?
Ratio of household debt to disposable personal income:

From 2000 to Q1 2004, the growth in financial debt mirrors the growth of household debt. Much of it is due to new financial practices in which personal debt instruments such as mortgages, consumer credit and student loans are "bundled" together and sold as mortgage-backed securities and asset-backed securities. These securities are then purchased by the investment community in general (including mutual funds and insurance companies), thus transferring the income and risk from the originators of the loans to the purchasers of the securities. The two largest entities in this phenomenon are Fannie Mae and Freddy Mac. This practice explains why the supply of credit seems endless - the original creditors sell the loans and are then in a position to make additional loans. There are many risks in these practices, however, including defaults on the original loans, a fall in asset values, and mismatches between interest paid on the underlying assets and the current market rates (the same risk that brought about the collapse of the savings and loans a decade ago.) This is potentially one of the most fragile areas of the current economy.

The escalation of debt growth noted since 2000 continued in the first quarter of 2004. Non-financial debt rose at a seasonally adjusted annual rate of 8.6 percent, Federal debt grew at an 11.6 percent rate, household debt at a 10.9 percent rate, and financial debt at a 7.3 percent rate. These increases, as we have noted, made it possible to maintain rising consumption levels through reductions in personal taxation and accelerated depreciation allowances for business. The question now is whether such policies can ignite a new boom as in the nineties or whether they will undermine the financial soundness of the entire debt market.

Non-farm Employment (thousands)

Average Yearly Increase
1992-2000 2000-2002 2003 FQ 2004
Goods-producing industries 177 -1,046 -740 -102
Services-producing industries industries 2,721 324 330 532
 *nbsp; Government 268 362 62 -31
Economic Indicators

No area of the economy was affected more decisively by the downturn than employment. Total employment increased at an annual rate of 2.9 million during the nineties, fell .7 million in 2001-2002, fell .4 million in 2003, and rose .4 million in the first quarter of 2004.

Employment growth in goods producing industries has been particularly weak. Within this sector, manufacturing employment fell 105 thousand per year even in the nineties, but this loss was offset by gains in construction and other areas. Losses continued in manufacturing all through 2001-FQ 2004 (a.r.) while gains in other areas were small. The losses in manufacturing employment during the nineties occurred despite rising production through the period, but they strengthened when production faltered after 2000. Clearly this weakness is a reflection of higher productivity.

All of the gain in total employment during the 1992-FQ 2004 period occurred in the services producing sector. But as the table shows, the pace of growth in this sector has slowed sharply. From annual gains of 2.7 million in the nineties, it fell .3 million in 2000-2, rose .3 million in 2003 and rose .5 million in FQ 2004. There were gains in every major category of services employment during the nineties. But from 2001-2003 such major categories as Trade, Transportation and Utilities, Professional and Business Services, and Other Services have shown declines. The only sectors with consistent gains have been Education and Health.

In the first quarter of 2004 total employment rose 436 thousand over the 2003 level, of which 534 thousand was in services. Manufacturing continued to fall (199 thousand) while the major gains in Services were in Trade (77 thousand) and Education and Health (197 thousand). These gains would have to be maintained through the year even to approximate the annual gains of the nineties.

The Great Riverboat Gamble

Today's economy is addicted to growth to maintain prosperity. Growth is essential not just to accommodate a rising population but more importantly to generate new jobs to replace those eliminated by rising productivity. During the nineties, growth was sustained by constant credit growth and a great investment boom in technology. This boom went to excess when demand for the new products and services did not meet expectations. The resulting collapse led markets and the economy into a steep decline.

Policy makers are attempting to revive the boom with unprecedented fiscal and monetary stimuli - tax rebates, tax cuts, investment subsidies, and historically low interest rates. These policies are creating massive levels of indebtedness which the policy gamblers hope can be met through ever rising income growth. The strange thing about all this is that even though we have productive capability undreamed of through the ages, we have come to the point that we must risk everything on one desperate throw of the dice - revive the boom or face a fundamental re-ordering of the economic system.

The question now is what will the dice roll?

International Comparisons
Canada Germany Japan United Kingdom United States
GDP (% chg. from same quarter a year earlier)
    2002 (Q4)
3.5 0.5 2.2 2.2 2.9
    2003 (Q4)
1.6 0.2 3.2 2.5 4.3
    2004 (Q1)
1.6 1.5 5.4 3.0 5.0
Industrial Production (1997=100)
117.3 109.9 91.7 99.7 110.9
117.5 110.3 94.5 99.2 111.1
    FQ 2004
119.4 112.6 98.1 98.6 114.3
Retail Sales (volume chg. on year ago)
    2002 (Dec)
1.4 -3.2 -3.0 6.4 4.9
    2003 (Dec)
0.8 -2.5 0.4 4.0 7.4
    2004 (March)
4.9 -0.7 -2.2 6.4 9.2
Consumer prices (1982-84=100)
172.9 146.7 119.0 207.0 179.9
177.7 148.3 118.7 213.0 184.0
    FQ 2004
179.0 149.6 118.3 216.0 186.3
Unemployment Rates
    2002 (Dec)
7.5 10.1 5.3 3.1 6.0
    2003 (Dec)
7.4 10.4 4.9 4.9 5.7
    2004 (March)
7.5 10.4 4.7 4.8 5.7
Interest Rates (3 months)
2.67 2.94 * --- 3.84 1.19
2.59 2.15 * * --- 3.74 .90
    FQ 2004
2.13 2.06 * --- 4.02 .92
Stock Indices (ending)
6,614.54 2,892.63 8,578.95 3,940.40 8,341.63
8,220.89 3,965.16 10,676.64 4,476.90 10,453.92
    FQ 2004
8,585.93 3,856.70 11,715.39 4,385.70 10,357.70
Current Acc't Bal's ($bn) latest 12 months
11.0 50.4 115.0 -13.1 -480.9
18.5 56.3 136.0 -30.8 -541.8
    FQ 2004
20.9 63.3 153.2 -39.2 -537.3
Foreign Exchange Rates
1.57 0.95 * 125.22 1.50 126.75
1.40 1.13* * 115.94 1.63 119.28
    FQ 2004
1.32 1.25 * 107.17 1.84 113.3
Currency units per U.S. $
UK pound in U.S. $s
U.S. dollar: index of dollar against major trading partners, January 1997=100
* Euro area (US$/Euro)
Sources: Economist, Economic Indicators,
F.R. Bulletin, Survey of Current Business

Japan and the U.S. show the best GDP gain over the year earlier period in first quarter 2004, with smaller gains in Germany and the U.K. Canada, the U.S. and Germany increased their industrial production while Britain and Japan remained below the 1997 base level.

Retail sales grew very strongly in the U.S. and increased in the other countries except Japan. Britain and the U.S. are the only countries with consistent strong growth.

Japan remains free of inflation, but the other four countries continue to experience consumer price rises of up to 3 percent per year. British prices have more than doubled since the base period 1982-84.

Unemployment rates have been consistent since December, 2002, with no trend up or down. Interestingly, short term interest rates have also been trendless; if the world economy is growing strongly, one would expect rates to be rising. The assumption that it is not seems to be supported by the stock indices, which were lower for the quarter in Germany, Britain, and the U.S; investors do not seem to expect a strong upturn over the immediate future.

The three current account surplus countries increased their balances in the latest period while the deficit countries - Britain and the U.S. - increased and slightly decreased their balances, respectively. It may be a coincidence, but the deficit countries are also the two that experienced consistent strong retail sales growths.

The persistent U.S. trade deficits do seem to be affecting the value of the U.S. dollar, which has fallen from an index of 125.91 in 2001 to 114.26 in March 2004. By contrast, the Canadian dollar, the euro, the yen, and the British pound have all risen in value.

Business Activity Indicators - United States
2002 2003 FQ 2004
Industrial Production (1992=100) 110.9 111.1 114.3 *
    Capacity Utilization Rate (% total industry)
75.6 74.8 76.4
Manufacturers' New Orders (billions of $s) 316.7 329.2 350.3 #
New Construction Expenditures (billions of $s) 860.9 898.3 * 939.6 *
Real Gross Priv. Dom. Invest. (chained[1996]$s) 1,572.0 1,638.0 1,756.4 *
Business Sales - Mfg. & Trade (billions of $s) 822.0 857.0 909.0 #
Business Inventories (ending) (billions of $s) 1,163.7 1,185.5 1,196.7
Retail Sales (billions of $s) 269.2 283.3 296.2 #
Retail Inventories (ending) (billions of $s) 430.5 451.5 455.1
Per Cap. Personal Consump. Expend.'s (chained 2000 $s) 24,773 25,303 25,807
Nonagricultural Employment (millions) 130.3 129.9 # 131.8
    Goods Prod. (millions)
22.6 21.8 21.7 #
    Services Prod. (millions)
107.8 108.1 108.6 #
* Annual Rate
# Monthly average
Source: Economic Indicators

Real GDP increased 3.9 percent in the first quarter of 2004 after rising 4.1 percent in the fourth quarter of 2003 and 3.1 percent for all of 2003. Personal consumption expenditures contributed most to the rise.

Industrial production picked up after three years of little change. The pick up was led by durable goods, especially computers and electronic products. Capacity utilization increased moderately after three years of decline. Manufacturers' new orders show a continuing pick up after first turning up in 2003.

New construction expenditures reached a new high in April 2004 with close to two million housing units started on an annual basis. The boom is concentrated in new housing as home prices soar in certain parts of the country.

Gross private investment turned up in 2003 after two years of decline, and increased further in the first quarter of 2004. The strength is concentrated in equipment and software and in new housing.

Business sales accelerated in 2003, and this trend continued in the first quarter. Retail sales have grown consistently and continue to do so. Business and retail inventories have been rising, but inventory-sales ratios are low. The consistent growth in retail sales has been underpinned by rising per capita personal expenditures.

Nonagricultural employment reached its low point in August 2003 and by May 2004 had risen 1.4 million. Manufacturing did not participate in this upturn, but construction added 170 thousand jobs. The remaining growth was in services, especially professional and business services, education and health, leisure and hospitality, and transportation and utilities.

Financial Indicators - United States
2002 2003 FQ 2004
National Income (billions of $s) 9,290.8 9,707.7 * 10,182.9 *
    Percent change
3.4 4.5 4.9
Per Cap. Disp. Personal Income (chained [2000]$s) 26,355 26,800 27,326 *
Avg. Real Gross Wkly Earnings (1982=100) 278.83 278.75 279.23
Gross Saving " 1,539.3 1,484.8 1,632.1 *
Consumption of Fixed Capital " 1,288.6 1,310.9 1,338.2 *
    Net Saving "
250.7 173.9 293.9 *
      Private "
494.1 587.6 711.3 *
    Government "
-243.4 -413.7 -417.4 *
Commodity Price Index (1995=100) 74.7 89.0 99.8
Producer Price Index (1982=100) 138.9 143.3 146.0
Corp. Profits (with i.v.a.&c.c.a.) (billions of $s) 904.2 1,070.0 1,220.0 *
Interest Rates - 10 year Treas. 4.61 4.01 4.02
Money Supply - M3 (ending) " 8,550.1 8,827.8 9,012.8
    Percent change
6.6 3.2 2.1
Commercial Bank Credit (ending) " 5,887.1 6,255.4 6,509.2
Consumer Credit (ending) " 1,902.7 1,996.2 2,027.0
Credit Market Debt (ending) " 31,343.7 34,029.1 34,625.5
    Nonfinancial Sector "
21,233.0 22,949.0 23,392.7
    Financial Sector "
10,110.8 11,079.2 11,232.8
    Household Sector "
8,388.7 9,281.4 9,458.8
Total bankruptcy filings (thousands) 1,576.1 1,659.6 407.6
* Annual rate Sources: Economist, Economic Indicators, F.R. Bulletin, F.R. Flow of Funds, Administrative Office of the U.S. Courts

National income increased more in the first quarter (annual rate) than in all of 2003. The increase was mostly in compensation of employees (reflecting higher employment) and in corporate profits. These increases, in turn, led to a steep increase in per capita personal income. Average weekly earnings also rose in the first quarter after a small decline in 2003.

The BEA has changed its 5.1 table from "Gross Saving and Investment" to "Saving and Investment". Under the former format, gross private and gross government saving were shown along with a breakdown that listed "Consumption of fixed capital (which is subtracted from gross saving to arrive at net saving). Under the new format, net private saving and net government saving are shown followed by an itemized breakdown of "Consumption of fixed capital." Our presentation has been changed to reflect these changes. The primary message of the data is that private net saving has increased while government net saving has become negative due primarily to the tax cuts.

The surge in commodity prices appears to be due to a number of factors including rising demand in Asia, the weakening of the U.S. dollar, and speculation. For perspective, the rise only brings us back to the 1995 level. Most producer price categories continued the upsurge that began in 2003; capital equipment prices continue to lag, implying weak demand.

Corporate profits grew strongly in the second half of 2003, primarily in the non financial sector, as production accelerated; first quarter 2004 profits were lower than the preceding quarter, however.

The interest rate on the 10 year Treasury bond rose from 3.33 percent in June 2003 to 4.74 percent in April 2004. So far, the upsurge in interest rates has been pretty modest.

After slowing in the last four months of 2003, M-3 money supply resumed its long expansion. Commercial bank credit also expanded in the first quarter, led by Treasury/agency securities and real estate loans; commercial and industrial loans continued to lag. Consumer credit grew strongly in January but has since slowed noticeably.

Non financial debt rose 8.6 percent (a.r.) in the first quarter, slightly more than in 2003, while financial debt grew 7.3 percent, considerably less than in 2003. The household sector grew 10.9 percent compared with 10.4 percent. Clearly the credit market is still making a strong contribution to maintaining economic growth.

Bankruptcy filings in the first quarter were slightly below the 2003 pace.

Selected International Transactions - United States
2002 2003 FQ 2004
Trade Balance on Goods & Services ($bns) -421.7 -496.5 -136.9
    Goods "
-482.9 -547.6 -150.8
    Services "
61.2 51.0 13.8
U.S. Owned Assets Abroad, net [inc/capital outflow(-)] " -198.0 -283.4 -289.3
Foreign Owned Assets in US, net [inc/capital inflow(+)] " 768.2 829.2 447.6
    Net change in US Int'l Inv. Pos'n "
570.2 545.8 158.3
Net change in Foreign Owned U.S Securities
    Treasury Securities & Cy Flows "
182.4 299.8 164.7
    Other U.S. Securities "
317.7 281.0 76.8
Sources: Economic Indicators, Survey of Current Business

The trend to ever-larger trade deficits continued in the first quarter of 2004. The deficit on goods increased while the surplus on services was about unchanged. Both goods exports and imports increased, mainly in industrial supplies and materials and in capital goods. Services exports and imports also increased, especially travel and transportation-related items.

Financial inflows and outflows were heavy in the first quarter, but outflows increased more than inflows. Claims on and liabilities to foreigners reported by U.S. banks constituted a significant part of these changes.

Foreign official and private purchases of U.S. Treasury securities remained strong in the first quarter. Together they financed about 37 percent of the federal current deficit.

Foreign purchases of U.S. securities other than Treasuries were little changed except for an increase in official agency holdings.

Copyright © Andrew Caughey, 2004

The Pulse of Capitalism is published quarterly. Comments may be sent to Pulse Publication, P.O. Box 140, Gibsonia, PA 15044. Telephone: (724) 443-2396
Material may be reprinted with acknowledgement of the source. Economic statistics are revised routinely and may, therefore, differ from one report to another.

Published July 2004

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