This is worth noting. It comes from an analysis of today's retail sales figures by Bernard Baumohl, managing director, the Economic Outlook Group:

What did surprise us in this report was the drop in sales of gasoline. Americans spent 0.4% less on gasoline in April than the month before. Was this the result of people driving less and thus not filling up their tank as often? Or did prices actually decline last month? We took a look at the retail price of gasoline as compiled by three sources, the AAA, the DOE's Energy Information Administration (EIA), and even GasBuddy.com!

All showed gasoline prices increased sharply in April. So the explanation behind the fall in gasoline spending had to be a decline in consumption. Indeed, what is showing up in the data compiled by the EIA is that demand for gasoline has been flattening out the past year. Clearly, the price of filling up a tank has now reached the pain threshold for an increasing number of drivers, forcing them to either take public transportation or replace their gas guzzling SUVs with more fuel-efficient autos.

I got an email press release the other day trumpeting, among other things, the following:

Fannie Mae will allow borrowers to refinance up to 120% of their home value if they are currently paying their mortgages on time.

'This is a huge positive development for responsible homeowners who are faithfully making their payments, but simply find themselves in a negative equity situation due to declining real estate values,'....

Isn't it deals like this that got so many homeowners in financial trouble. It's a bad move.

Well, employers didn't cut anywhere near the number of workers expected by a majority of economists. Payrolls dropped by -20,000 vs. a consensus expectation of -75,000. The unemployment rate is at 5%.

The job losses are still concentrated in construction, manufacturing and retail trade. Jobs were added in healthcare and in professional and technical services, according to the Bureau of Labor Statistics. It's still a blue-collar and pink-collar recession. For instance, the unemployment rate of workers with less than a high school education rose from 7.6% in December, 2007 to 7.8% in April of 2008. The unemployment rate for workers with a high school diploma increased from 4.7% to 5% over the same time period. But the unemployment rate is down (a fraction) for workers with a bachelor's degree or more--from 2.2% to 2.1%.

It's beginning to look like a short and shallow recession.

Here's the question I posed earlier in the week:

Will the downturn be short and shallow or deep and vicious? With all apologies to William Shakespeare, that is the question. It isn't an idle one, either, and it's difficult to answer with any degree of confidence even though it's increasingly clear the Federal Reserve has succeeded in its several months-long campaign to prevent a credit crunch from turning into a financial collapse. The quarter-point cut Apr. 30 in its benchmark interest rate to 2% is probably the central bank's last maneuver in that crusade for some time.

Even though the risk of apocalypse has been averted, the economic glass could be half empty. Perhaps most worrisome is the nearly 13% price decline in residential homes from a year earlier in 20 major metropolitan markets followed in the Standard & Poor's/Case-Shiller index. The housing market's downward momentum shows no signs of abating.

The government's latest gross domestic product report has business spending falling across the board, with outlays on residential and non-residential construction, capital goods, equipment, and software down in the first quarter of 2008. Consumer confidence is falling, too. One figure in the Conference Board's April report caught the eye of Bernard Baumohl, managing director of the Economic Outlook Group in Princeton , N.J. The proportion of people surveyed who expect their incomes to rise over the next six months fell to 15.1%, "the lowest percentage this organization recorded since 1967 when it began this line of questioning," he writes.

Still, there is a chance the glass is half full. Take the stock market. It's barely in correction territory, down less than 11% from its peak reached in October, 2007. The Bush Administration's $168 billion rebate to taxpayers will start reaching consumers soon, with at least some of that money spent at malls and big-box stores. The forward earnings of the S&P 500 are down only 5.4% at the end of April from last October's record high, according to economist Edward Yardeni of Yardeni Research. That compares to a 17.5% peak-to-trough decline during the previous profits recession at the beginning of the decade, he adds.

So, half empty or half full? The April employment report due out on May 2 could provide an answer. "Central to the outlook for the economy in the balance of this year is just how much has the job market weakened," says James Paulsen, chief investment officer at Wells Capital Management, which is part of Wells Fargo.

Certainly, last month's payroll plunge of 80,000--the biggest drop in five years--convinced a majority of private sector economists that the U.S. was in a recession or sliding toward one. (A close look at the numbers behind the 0.6% gain in GDP in the first quarter of 2008 won't persuade many economists to change their outlook.) Jobs matter.

One key measure is simply, how big is the payroll drop? The Bloomberg survey of economists for April's employment report has a consensus decline of -75,000. That figure would be consistent with a business community facing tough times but reluctant to embrace mass layoffs. If payrolls come in around consensus that would suggest a short, shallow recession, says Mark Zandi, chief economist at Moody's Economy.com. (He's forecasting a 100,000 decline.)

What if the job number jumps to the 150,000 to 200,000 level? Those figures are consistent with the job market of a typical post-World War II recession. Assuming history holds, the downturn would come to an end around the time summer shades into fall. But payroll declines in the 250,000 to 300,000 range would suggest a vicious downturn. The recovery wouldn't start until the end of the decade, Zandi says.

It's not just the magnitude of the payroll drop that matters. Who gets handed a pink slip also counts when trying to fathom the economy's direction. So far, this has been largely a blue-collar and pink-collar downturn. Job losses have been concentrated in industries such as manufacturing, construction, and retail, and it's the less-educated workers in these industries that are suffering the most on the job front. For instance, the unemployment rate for workers with less than a high school diploma is up from 7.6% in December to 8.2% in March. Workers with a high school diploma have also seen an increase over the same time period, from 4.7% to 5.1%.

In sharp contrast, workers with a bachelor's degree or higher are doing relatively well, despite massive layoffs at a number of beleaguered financial institutions. For example, the unemployment rate for well-educated workers fell a fraction from December to March—2.2% to 2.1%. Watch out if the job-loss figure spreads to better-educated and better-paid workers in such white-collar professions as health care, education, and information technologies.

In a sense, everything flows from jobs. The more confident workers are that they won't join their neighbor at the unemployment center, the quicker home prices and consumer spending revive. Of course, the exact opposite dynamic holds, too.

I think America's embrace of household debt is on the wane for a number of reasons. Among the most important reasons is that lenders have learned the hard way that the consumer is a riskier borrrower than they thought.

But on a more positive note it seems that the growing embrace of "sustainability," especially among young people, could give added impetus to a trend of avoiding debt and saving more. It's striking how discussions on sustainability, say, on the merits of various ways to lower your carbon footprint, often include asides on staying away from The "sustainability" movement and its message of conservative consumerism and fiscal probity could end up moving from the tributaries of society to the social mainstream. (Much as organic foods moved from the rare coop in certain neighborhoods to the grocery aisles at Wal-Mart.) The sustainability gospel that "less is more" gives additional momentum to a greater appreciation of thrift.

At least this is an idea I'm exploring.

Most Americans are well aware that we have greater poverty here than in Europe. We don't redistribute as much money from the well-off to the poor. America relies more on charity and the non-profit sector to deal with poverty than government, too. But the main response to these observations over the years has been, "so what?" America has a lot more social and economic mobility than Europe. We're a bootstrap nation.

Problem is, America and Europe are similar when it comes to economic mobility. Harvard University economists Alberto Alesina and Edward L. Glaeser reviewed the recent empirical literature in their book Fighting Poverty in the US and Europe. The message from their literature summary is that there may be slightly more mobility in the American middle class than in Europe, but the difference is so small its insignificant. But in the U.S. if you're born poor the odds are you'll stay poor. The same isn't true in Europe.

For instance, according to one study they review, a comparison into mobility in the U.S. and Germany, about 60% of the bottom quintile of the U.S. population stays in that low-income group over the nine years studied vs. 46.3% in Germany. "If anything, the American poor seem to be much more 'trapped' than their European counterparts," write the authors.

What's more, considering the striking increase in income inequality in the U.S. over the past three decades, the risk grows bigger that the promise of equality of opportunity is turning into inequality of opportunity.

Warren Buffett's annual report is always a wonderful read, full of insight and investment wisdom. A number of people have talked to me about this passage:

I should mention that people who expect to earn 10% annually from equities during this century - envisioning that 2% of that will come from dividends and 8% from price appreciation - are implicitly forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about double digit returns from equities, explain this math to him - not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: "Why, sometimes I've believed as many
as six impossible things before breakfast." Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.

I couldn't agree more.

Buffett's musings on investment returns reminded me of an academic paper I read several years ago with the improbable title, "The DJIA Crossed 554,428 (in 1997)." You can imagine my skepticism. But this wasn't one of those "Dow 36,000" or "Dow 40,000" forecasts that was popular at the end of the '90s. It was serious research into how equity values are measured. The authors, Meir Statman, a finance economist at Santa Clara University, and Roger Clarke, an international money manager, made an observation about returns that has stuck with me.

The Dow Jones Industrial Average, the most famous measure of the stock market, started out with a value of $40.96 in 1896. That year, an 18 year-old with that sum in his wallet--about $700 in 1997--could have had a terrific evening about town with some friends. Or, he could have invested the $40.96 in the stocks that made up the Dow Jones Industrial average and reinvested all the dividend income. By the 1997--at the creaking old age of 122--he would have accumulated a nest egg of $540,294. Of course, all the money would go toward medical bills. On the other hand, he could have spent the dividend income and still have $7,908 left over. "These are just three of the infinite number of ways you could be rich if you had $40.94 in 1896," say Statman and Clarke.

Investment returns is only one part of the equation. We don't eat total returns. It's what you do with the money that matters.

The decline in consumer spending will drag on the economy for a considerable period of time, even when the economy emerges from recession. It's doubtful that the recovery will be particularly robust with credit tight and consumers strained.

Here's a nice analysis of the consumers situation from the Quarterly Review and Outlook from Hoisington Management.

Going forward, the main problem for the U.S. economy is likely to be a protracted period of restrained consumer spending. In the expansion from 2002 to 2007, real Personal Consumer Expenditures (PCE), which comprised 71.5% of GDP at the end of last year, posted a 3.1% per annum increase, down from 3.5% and 4.2%, respectively, in the expansions of the 1990s and 1980s (Chart 2). The subdued gain in spending would have been even less had consumers lived within their means, as real personal income (2.5%) expanded less than the spending rate. With spending outpacing income, the personal saving rate dropped from 2.4% in 2002 to 0.4% in 2007.

A disparity of 0.7% per annum between the growth of income and spending might seem insignificant until you consider that income must also support all the other demands on consumers -- investment in housing and other real assets, financial investment, and gifts to charitable and other causes.

The story of the past several years is how much the gains in the economy have gone to a few at the top. Instead of a rising tide lifting all boats, it has been a rising tide lifts a few yachts. It isn't a healthy state of affairs for the American economy or society.

The main cause of the weaker trend in personal income in this decade was lackluster real wage and salary income that rose just 1.8%, or one-half the rate of gain in the expansion of the 1990s. This meager gain was caused by the sluggish .8% payroll employment growth rate that was the smallest of any expansion since World War II. With this key determinant of consumer spending restrained, consumers lived well beyond their means, only because their paper worth was boosted by surging home prices.

Families boosted their standard of living with women entering the workforce in droves starting in the 1970s. The rise of two income couples masked the slow growth of overall wages. In the '90s and '00s credit cards, home equity loans, and mortgage refinancing helped families increase their buying power. Much of the growth in debt reflected an attempt by families to keep up their standard of living at a time when incomes weren't growing much. But now families are strapped trying to meet interest and principal payments, their savings are tapped out, their home values are crumbing. Debt is no longer an option for shoring up living standards. There isn't another financial rabbit Americans can pull out of their hat.

The problem going forward is that real wealth is now declining, with the bottom yet to be found. Assuming home prices fall only 30% from their peak (some estimate a 50% decline), while stock prices rise 10% from the first quarter level and inflation is 2% per annum, the real wealth loss is about $7 trillion (Chart 4). Using the $1 to 7.5 cent ratio, this will constitute a drag on real PCE of 1.8% per annum from 2008 to 2010. Considering that the 3.1% rate of increase was the last expansion's average, a 1.8% drag will be a 60% reduction in consumer spending growth over the next three years just from the cash out/wealth effect alone.

Zvi Bodie,finance professor at Boston University, pointed out today that that with I-bonds the fixed 30-year rate of interest is still 1.2% per year (plus the actual rate of inflation), but it almost certainly will fall when it is reset on May 1. The limit per person is $5,000 in electronic form at www.treasurydirect.gov and another $5,000 per person in paper form at banks.

I-bonds are a great way to save. No credit risk. Taxes deferred until the bonds are cashed in. And you dollar is safe against the ravages of inflation.

Homeownership has been long a vibrant part of achieving the American Dream. But these days owning a home is more like starring in a horror flick, perhaps called Nightmare on Main Street. The numbers are frightening. Home prices are falling nationwide, and the foreclosure rate is at record levels. The delinquency rate for subprime adjustable rate mortgages is an astonishing 20%, and the Federal Reserve's home equity measure is at its lowest level in 60 years. Moody's Economy.com estimates that more than 10% of the nation's homeowners were "upside down" on their mortgages at the end of March--meaning that the value of their mortgage is greater than what their home is worth.

It's a safe bet that with both the housing market and the economy deteriorating more federal money (as well as state funds) will go toward supporting housing this year. But once the downward trajectory moderates, the government should learn from recent experience and take a radical stance: Forget propping up housing. Instead, eliminate the many taxpayer subsidies for housing. Yes, you read that right.

There's no question the U.S. tax code is full of special tax provisions that favor housing. Among the biggest breaks are the mortgage interest deduction, the deduction for state and local real estate taxes, and the capital gains exclusion for homes. (The first $250,000 in profit is exempted from capital gains taxes for individual filers, and a $500,000 profit for couples). The federal tax code funnels more than $100 billion dollars annually into the housing sector, estimates the Tax Foundation in Washington D.C.

This figure doesn't include the mammoth subsidized institutions that support the housing and mortgage markets. This includes Government Sponsored Enterprises like Fannie Mae and Freddie Mac, to name only two of the best known players. The Congressional Budget Office estimated that in 2003 the benefit of the explicit and implicit ties to the federal government for GSE like Fannie Mae and Freddie Mac amounted to a federal subsidy of more than $23 billion, according to economists William G. Gale, Jonathan Gruber and Seth Stephens-Davidowitz in their 2007 paper, Encouraging Homeownership Through the Tax Code.

Yet in a modern, dynamic high-tech economy why should homes get preferable tax treatment over stocks and other investments? The tax gap in treatment is significant. Take capital gains. Say you'd invested in a basket of high-tech stocks three years ago and now you sell the portfolio for a $500,000 profit. Well, you'll pay a 15% capital gains tax rate on the gain, writing a $75,000 check to Uncle Sam. But you and your husband also sell the home you bought three years ago for a $500,000 profit. Guess what? The Internal Revenue Service gets nothing. Indeed, the economy-wide tax rate on housing investment is close to zero compared with a tax rate of some 22% on business investment, according to the President's 2005 Advisory Panel on Federal Tax Reform.

By the way, the tax break for capital gains on housing was signed into law in 1997. Is it a coincidence that home prices soared 79% of the time between the first quarter of 1997 and the first quarter of 2005, with home prices not just going up but rising at an increasingly rapid rate, as calculated by Peter Bernstein, a long-time advisor to institutional investors and author of Against the Gods: The Remarkable Story of Risk? It's doubtful.

What's more, the mortgage interest deduction is bad tax policy. It's sold as a middle class subsidy, but it doesn't really work as advertised. The reason is that the biggest break is enjoyed by the highest income households. For instance, the President's Tax Reform commission calculated that individuals making more than $200,000 a year received more than 8 times the benefit of those earning between $50,000 and $75,000 a year. In addition, the rate of homeownership in Canada, Australia and Britain is comparable to the U.S., but these countries do not have the mortgage interest deduction subsidy.

These days, no one can doubt that a home is an investment. It's an asset class, like stocks and bonds. Indeed, one reason why housing prices hit such stratospheric heights was the potent combination of owners treating homes as an investment, and the capital markets shoveling huge sums of money into real estate through such innovations as collateralized mortgage obligations (CDOs). For awhile, the net effect was to increase the liquidity of real estate "investments", supporting an unprecedented degree of speculative activity.

The tax code shouldn't bias investment money to favor one kind of investment over another--certainly not in an intensely competitive global economy. Let the economic fundamentals dictate where investors place their financial bets on the future rather than the tax-writing prejudices (and campaign contribution solicitations) of Congress and the White House. "The current tax system distorts the economic decisions of families and businesses, leading to an inefficient allocation of resources and hindering economic growth," reads the final report of the Tax Reform commission.

To be sure, calling for the end of housing subsidies is at best reminiscent of tilting at windmills. (Does anyone really remember the President's 2005 tax commission? The report was buried fast.) Governments have long favored housing. The world's first subsidy Constantinople, speculates David Smith, founder and head of the Affordable Housing Institute in Boston. The subsidy was a perpetual grant of a ration of bread--the panes aedium. It was given to anyone that built a home in the city, and the panes aedium was passed along to the new home owners at sale. "Strikingly, the panes aedium was not just a first-time home buyer incentive, but an ongoing property asset, in much the same way as real estate tax abatements or exemptions are intrinsic property rights in the modern," writes Smith.

That said, the lesson of the past decade is that too much investment money goes to real estate in modern America. At a time when companies from China, India, South Korea, Brazil and other emerging markets--as well as traditional rivals from Europe and Japan-- compete with American firms for markets and profits, it's time to take residential real estate off its tax-favored pedestal..