July 2008 Archives

Two weeks ago, I played MC at a day long conference at the Federal Reserve Bank of Minneapolis. Among the talks was a look at returns to schooling by Lance Lochner, economist at the University of Western Ontario.

The returns to college for those that got their B.A. was around a real (inflation-adjusted) 20% for white men, up from about 15% in 1980. A college sheepskin still beats the real return of 7% on stocks by a considerable margin. The returns on compelting a college education have come down a bit since 1990 for African-American men, from around the 22% level to 20%.

But what really surprised me was the return on competing high school--slightly above 50%. Yes, you read that right. That's a real return. Now, most economists are suspicious of any return figure that high. But Lochner made a convincing case that the challenges so far have managed at most to shave a few percentage points off. For African-American men the figure is slightly higher, in the 56% range.

Here's the puzzle. The long run returns on a college degree rose modestly, but there has been a continuous and sizeable rise in college attendance. In essence, the market worked. Yet when you look at high school completion rates, they are down slightly since 1970s while the rate of return on graduating went up (eyeballing his chart, from about a 30% rate of return since the early '70s to around 50%).

So, according to Lochner, "returns to high school are substantially higher than college and have increased more rapidly in recent decades. High school graduation rates actually declined in recent decades."

What's going on here?

I got a call from a financial advisor this morning, and he had seen a calculation that with zero percent interest financing and all the price cuts/discounts being put on the Yukon, gasoline would have to hit $8 a gallon before the SUV became uneconomic. If he's right, that's a stunning number.

Although measuring teenage employment during the months when school is out, these numbers from the Cleveland Fed highlight a depressing story when it comes to summer jobs.

In May, the unemployment rate for teenage workers increased from 15.4 percent to 18.7 percent, as large numbers of young workers entered the labor market but had yet to find jobs. June's unemployment rate for teenagers sagged slightly to 18.1 percent but remains at a very high level. However, 359,000 teenagers left the labor force this month, which is a large number considering the overall labor force decline of 144,000.

These numbers confirm my own anecdotal sense that teenagers are finding it hard to get jobs. Instead, they're relying more on their parents to pay them for work around the house, such as tackling the garage or painting the deck.

Income inequality has worsened ovre the past three decades or so. Economists in the Global Economics Research area of UBS recently took a look "inflation inequality."

Two results aren't surprising. The top income group is the least likely to suffer from rising prices. Low income Americans since 2000 have seen their price index rise by over 7% more than higher income American consumers.For the low-income it's food and healthcare, as well as utilities and heating bills, that are the drivers behind inflation pressures.

So far, no real surprise. What's different, the economists argue is that "this time the middle class in America is sharing inflation 'pain' with lower income groups."

But the force behind middle class inflation is different from lower class inflation. For the middle class, gasoline is the big culprit. Call it the price of an SUV culture. Middle class families also have greater room to manuever for financial relief:

The damage to standards of living for middle-income families is not entirely clear, however. The middle-income family has scope to change their consumption habits in a way that lower-income groups do not. In economic parlance, middle-income families have price elasticity as to their demand. A middle-income family has a choice of where to shop for food, for instance, and may prefer to substitute own-label products, or discount stores, to maintain their standard of living, but pay less to do so. Rather than buying premium grades of petrol, the middle-income family could chose to maintain their mileage, but downgrade the fuel used.

The UBS economists add that the trends they've highlighted are true across the OECD.

One way to track how the election is going is through political prediction markets. These futures contracts, which bet on the election outcome, trade on these markets just like corn or oil futures. One such betting market is at Intrade, an Irish-based futures market.

There is good reason to monitor the prediction markets: Academic research shows their track record at foretelling election outcomes is better than that of polling data. After all, investors aren't just pontificating--they have money on the line.

While the presidential futures markets are relatively new, betting on politics has
a long history. There were well-organized Presidential betting pools between 1868 and 1940, according to the book Historical Presidential Betting Markets, by economists Paul W. Rhode and Koleman S. Strumpf of the University of North Carolina, Chapel Hill.

In the late 19th and early 20th century, for example, betting on the Curb Exchange in New York (which evolved into the American Stock Exchange) and in the lobby of the New York Stock Exchange at times exceeded trading in stocks and bonds. In the New
York markets, wagering on a Presidential election peaked with some $198 million (in 2008 dollars) in bets placed in 1916. That's when Democrat Woodrow Wilson came from behind to defeat Republican challenger Charles Evans Hughes. The amount gambled that year was twice the sum spent on the campaign. Rhode and Strumpf calculate that an average of $44 million, in 2008 dollars, was bet during Presidential contests from 1884 to 1928.

Here's an interesting note from Intrade from today:

The Political Prediction Markets

Obama's Intrade Market Soars, DOW Plummets: A Very Strong

(-0.91) Negative Correlation

(Dublin, Ireland -Tue. 15 July 2008) Intrade's market data shows that the sliding Dow Jones Industrial Average has an exceptionally strong negative correlation (approx. -0.91 over the last 10 weeks) with the rise in the Intrade Market for Barack Obama to be the next US President.

Intrade's market data shows that the weakening Dow Jones Industrial Average has an exceptionally strong negative correlation (approximately -0.91) with the strengthening probability that Barack Obama will win in November.

Between May 6th and July 10th Obama is up 11 points or 20.04%. The Dow is down 1791.81 points or -13.76%. The correlation for this period between Obama's rise and the Dow's fall is -0.91. On July 14th Obama closed at 68.0 with John McCain closing at 31.1, a difference of 36.9 or 54.26%.

The headlines are scary. U.S consumer prices soar. Consumer prices rise at an accelerated rate.

But Mike Mandel, chief economist at Business Week, has been blogging about the prospect of deflation. Yes, you read that right. I think he's right. (Full disclosure: I wrote a book about deflation. The time may come to reissue it?) The International Monetary Fund has also weighed in on the topic, arguing that deflation is a real risk in a decelerating global economy.

Check out what Mike has to say at his blog, Economics Unbound.

Right now, its popular to blame Greenspan and the Fed for what ails the economy. Just read the screeds coming out of the editorial page of the Wall Street Journal. I think history will come to a different judgment.

Economist Brad Delong at the University of California, Berkeley, certainly thinks so. He writes in defense of Greenspan's tenure as Fed chairman when it comes to booms and busts. He's spot on. This is something I've written about and talked about in a number of different forums, both Marketplace and Business Week. So has Mike Mandel, chief economist at BW.

In essence, the booms are how capitalism is transformed quickly, and the busts clean up the excess. Booms and busts are part of creative destruction. Greenspan deeply understood this. The job of the Fed isn't to stop booms, but to prevent the inevitable bust from taking down the entire economy.

The unwinding of the dot-com bubble in 2000-2002 went remarkably well: no significant macroeconomic distress, and less financial panic and distress than I believed possible. The unwinding of the real estate bubble in 2007-2009 is so far not going well. There is, by contrast, more financial distress than I believed possible.... But so far--look: In the dot-com boom of the 1990s we were the winners. The rich investors of America built out a huge amount of fiber-optic cables and conducted an enormous amount of experimentation in business models from which we all benefit. In the real-estate boom of 2000s the rich investors of America and the world built an extra four million houses and loaned the rest of us money at remarkably low interest rates for five years. Those who moved into newly-built houses with teaser-rate mortgages wish those teaser rates would continue--but they won't, and in the meantime they got to live in a nice house for quite a low rent. Those of us who took out big home equity loans wish the low interest rates would continue--but they won't. And those of us who felt rich because our house values have appreciated wish we still could think of ourselves as sleeping on a pile of gold--but we can't.

The dot-com bubble and the real-estate bubble were bad news for the investors in Webvan, WorldCom, Countrywide, FNMA, and securitized subprime mortgages. But they were, by and large, good news for the rest of us. And investors are supposed to take care of themselves.....

He goes on to say that we're not out of the woods yet, of course. And if unemployment and inflation breach 10% he'll change his mind.

But so far the real economy in which people make stuff and other people buy it has been remarkably well insulated from panic at 57th and Park and on Canary Wharf.

By this metric, Greenspan did a good job. It's also why I think Bernanke-bashing is misplaced.

There's probably little that I and Kimberley Strassel, editorial writer for the Wall Street Journal, agree on when it comes to the economy and public policy. But I couldn't agree more with her delicious screed against the airline industry blaming those oil "speculators" for the problems in the airline industry. Here's one highlight:

I'm betting those speculators at the Chicago Mercantile Exchange were behind the retention of that counter agent who recently placed me, my 3-year-old and my infant in completely different rows for a cross-country flight, instructing me to "sort it out at the gate." The CME undoubtedly also hired the gate agent who told me to "fix it on the plane." Ditto the stewardess who yelled at me for not dealing with this problem before I boarded and then ordered a dozen people to shift seats, delaying our departure. Not that it mattered, since we sat on the runway for two hours. But it's good to know what donkey I can pin that tail on.

And another:

And I'm beginning to get why the only way I can use my frequent-flier miles is if I agree to travel to Chattanooga, Tenn., in October 2011. Those oil-futures guys, they're tricky. I'm betting they've got some futures-hedge-put-short-thingy placed so that they will make a bundle if I touch down in that city a few years hence. Never underestimate the long con.

You can read the The Blame Game here.

The stock market staged a stong sigh-of-relief rally on friday on news that Citigroup's $2.5 billion dollar loss was better-than-expected.

But I didn't take much solace in the news. The growing losses in credit cards is worrisome. From today's Wall Street Journal.

A similar trend is evident in Citigroup's giant credit-card business. Defaults in North America rose in the second quarter to 6.53% of total loans from 5.81% three months earlier. That's the highest loss rate since mid-2005, when a wave of borrowers rushed to file for bankruptcy protection before a new law took effect that made it harder for them to wipe away their debts.

Mr. Crittenden [Citigroup's CFO] warned that credit-card losses could rise "beyond their historic peaks" of about 7%, a level last seen in early 2004.

The credit problems continue to spread.

From economist Ed Yardeni's newsletter this morning:

Ten years ago the S&P 500 was at 1186.75. The S&P 500 closed at 1260.00 yesterday, up just 6.2% over the entire 10-year period. In other words, investors in an index fund based on this widely followed measure of "the stock market" would have slept better keeping their money under their mattresses.

Ouch.

The economy is weak. We're probably in a recession. And it's hard to see the economy bouncing back anytime soon. I also expect it will take longer than normal for household budgets to rebound after GDP growth picks up.

That said, if you want to really worry I'd focus on education. Clive Crook, columnist for the Financial Times, recently wrote a disturbing article on declining educational levels in the workforce.

In 2002, the US enacted the bipartisan No Child Left Behind policy, which called on schools to boost standardised test scores in a limited range of key subjects and to raise graduation rates. The policy has been almost universally pilloried by teachers and education professionals, who complain that it encourages "teaching to the test", a narrowing of the curriculum and other forms of self-defeating gaming of the system. They complain, too, that they have been asked to do more with no increase in resources - complaints that have some merit.

Be that as it may, if the US is unable to mend its failing school system, and unwilling to open its doors wider to skilled immigrants, then much of the current gloom about its longer-term economic prospects may, for once, turn out to be justified.

The stock market is down, Housing is down. David Rosenberg, chief economist at Merrill Lynch, offers up this assessment:

With rebate check delivery winding down, there is now little shielding the consumer from the full force of $4+ gasoline, deflating real estate and equity markets and rising unemployment. The new reality means a deeper downturn for consumers, higher headline inflation, more belt-tightening from businesses and a mammoth profit squeeze. It also keeps the odds squarely in favor of more rate cuts from the Fed, in our view.