National Economic Trends – December 2010

It’s been kind of a snoozer lately with respect to major economic news. Economic data continues to
show accelerating growth, notwithstanding a lukewarm jobs report that we’ll explain away shortly.
Congress and the Administration returned to action for the lame-duck post election session and
immediately (if grudgingly) came to agreement on a framework for extending the Bush tax cuts for
another two years, thus averting (assuming its passed) the threat of higher taxes derailing the still
wobbly recovery. That doesn’t rise to the level of big news, however, since it would have been a
stunning surprise if they hadn’t. The Europeans, apparently tired of the Chinese getting all the
headlines, ginned up another financial crisis, this time involving Ireland, but the hysteria over that
development died down pretty quickly when people realized that you can swap Louisiana for the
entire Irish economy about even up (although you might have to throw in Beaumont to sweeten the
deal) and that just isn’t big enough to trigger a financial crisis worth worrying about on this side of
the pond. The Federal Reserve continued ramping up its asset purchase program per stated intentions,
but since Fed policy works with such long and variable lead times the impact on the broad economy
won’t be evident for some time yet. So enjoy your holiday grog/nappy time secure in the knowledge
that whatever it is that is going to make your life more difficult in 2011 hasn’t happened yet.
Ignorance can indeed be bliss.

The biggest economic news lately was

Labor Market Indicators
another soft employment report for Source: U.S. Dept. of Labor
(in 000's) (in %)
November. After several months of 600 12.0
encouraging gains there was great 400
10.0
anticipation amongst economic geeks that 200
8.0
this would be the month we finally turned -

the corner. Instead what we got was a (200) 6.0

piddling 39,000 new jobs, 50,000 in the (400)

4.0

private sector, and a 0.2% bump up in the (600)

2.0
(800)
unemployment rate to 9.8%. Since the
(1,000) 0.0
bulk of other labor market indicators have Nov-08 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10
been turning more positive lately we’re Change in Non-farm Payrolls Unemployment Rate

inclined to view this as more of a one-

month bump in the road than a major
disappointment. Initial claims for Initial Claims for Unemployment
Four Week Mo ving Average
Source: U.S. Dept. of Labor
unemployment, to use one example, have
been trending sharply downwards over the 500,000
last several months (although they are still 490,000
480,000
too high). The initial report is also likely to 470,000
be revised higher in subsequent re- 460,000
imaginings because that has been the trend 450,000
recently, and because at least one sector’s 440,000
430,000
estimate – retail sales – is likely off the 420,000
mark. The seasonally-adjusted number of 410,000
retail jobs was reported to have declined by 400,000Dec-09 Jan-10 Feb-10Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10
28,000 but we’re sorry, that just didn’t
happen. The unadjusted retail count
increased by 300,000, but that evidently wasn’t enough temporary hiring to appease the seasonal

Economic Trends December 2010.doc 1

adjustment model. There has been some speculation by the aforementioned disappointed economics
geeks that the timing of the survey in November was too early to catch a lot of the seasonal hiring and
that the result will be a big positive turnaround in the December report.

Since we mentioned earlier that Ireland was too small to trigger a major financial crisis you may have
wondered what country in Europe would be big enough. And since Europe has a bigger problem with
long-term spending trends than we do, get used to periodic crises. The accompanying chart (with
data from the International Monetary Fund and the Central Intelligence Agency) shows the relative
size of various countries economies as a percentage of total European Union GDP (the bouncing
balls) and measures of debt/spending as a percentage of GDP (the bars). As you may have expected,
Germany and France dominate the EU economy, with the U.K., Italy and Spain also being major
contributors. You get down below that, however, and the individual country economies are relatively
puny. The “At-Risk Countries” are the ones you’ve read about – Belgium, Greece, Ireland and
Portugal – and they cumulatively account for less than 8% of EU GDP or a little less than Spain all
by itself. So the odds of another global financial cataclysm being triggered by debt problems in any
country smaller than Spain are actually pretty remote.

As far as risk in concerned, there are two ways to look at things. One is the risk of sovereign default,
which can be measured by public sector debt as a percentage of GDP. By this measure Italy, at about
115% has an even bigger issue than the at risk countries, which collectively are just below 100%. At
some point it is believed that public sector debt becomes such a problem that it inhibits economic
growth. That ratio is generally believed to be around 100%, which may explain why Italy has such a
chronically underperforming economy. But it was private-sector debt (specifically mortgaged backed
securities) that triggered the most recent unpleasantness so perhaps total external debt is a better
measure of risk. Ireland’s principal problem is, in fact, the indebtedness of their banking system,
which went big into real estate all over the globe, resulting in total external debt of over 1,000% of
GDP (at some point, somebody should have cut up their credit cards). By this measure, the U.K.
represents even a bigger risk than the At-Risk Countries, with a ratio of over 400%. And even
Germany, considered the model of fiscal probity, clocks in at over 150%. (One thing we can learn
from this – when Europeans are interested in U.S. real estate, it’s time to sell.) In case you’re
wondering, even after our recent spate of profligacy the U.S. public debt ratio is around 55% and total
external debt around 95%.

450.0%

400.0%

350.0% 20.7%
300.0%
20.3%
16.2%
250.0%

200.0% 12.9%
13.3% 8.9%
7.7%
150.0%

100.0%

50.0%

0.0%
Germany France United Ki ngdom Italy Spain At-Risk Countries Other EU Countries

External Debt (as % of GDP) Publi c Debt (as % of GDP) - 2009 est. Budget Deficit (as % of GDP) - 2009 est.*

Economic Trends December 2010.doc 2

The final form of the tax deal is still uncertain as this is being written, but the general outline is that
the Congressional Republicans agreed to some of the President’s stimulus proposals, such as another
extension of unemployment benefits, in exchange for the President accepting the short-term extension
of the Bush tax cuts for everybody, including the wealthy, and a reinstatement of the inheritance tax
at 35% (it’s currently slated to go to 55%). The deal also includes a temporary roll-back of payroll
taxes that would counter the expiration of the “Making Work Pay” provision of the original stimulus
package. You likely forgot about this, but we all got a cut in our payroll taxes of up to $400 for
individuals and $800 for married couples which will expire December 31st. Since the tax cut was
added back to paychecks over the course of the year, nobody noticed and it didn’t much stimulate
spending. So the thinking of Washington is: if something doesn’t work, then try something else that’s
almost exactly the same, only bigger (about $1,400 per worker). There’s been some predictable
howling from the President’s liberal base about the giveaway to the rich, but we suspect the deal will
pass this Congress (it already has passed the Senate) because if they leave it to next year the President
won’t get a deal this good.

The real political action next year will be negotiations over a long-term plan to reduce the deficit. To
the great surprise of just about everyone the Presidential commission on the deficit came back with a
credible long-term plan to cut the deficit that involved cuts in popular programs (defense and social
security), as well as tax increases and an suggested overhaul of the tax code in general. The specifics
of the plan are unlikely to be implemented as such, but the Commission (actually mostly the co-chairs
Erskine Bowles, a moderate Democrat and
Alan Simpson, a moderate Republican) Treasury Bond Yield Curve
Source: The Federal Reserve
deserves credit for showing that it can be Annual %
done if our political leadership is willing to 5.0
4.5
make hard choices. That, of course, is the 4.0
3.5
rub. 3.0
2.5
2.0
We know we said that it’s too early to tell 1.5
if the Fed’s quantitative easing program is 1.0
0.5
working yet, but here are the early returns – 0.0
it’s not. Actually, that’s a little harsh. It’s
not working to drive down interest rates, Dec-09 Nov-10 Dec-10

which are starting to move upwards as

financial markets become convinced that Price of Gold
the recovery is beginning to accelerate. ($/oz., in London)
Source: Moo dy's Analytics
Mortgage rates in particular have leaped
about 0.5% over the past several weeks, 1400
1300
delivering yet another blow to the prostrate
1200
real estate market. It does seem to be
1100
working, along with the tax deal, to 1000
increase inflationary expectations, which 900
was a goal believe it or not. So as you go 800

to the gas pump this Yule season and pay 700

600
$3.00 plus per gallon (which is where retail Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
gas appears to be headed) you can thank the
Federal Reserve for being wise enough to
ignore prices for unimportant items such as food and energy in their quest to slay the deflation dragon

Economic Trends December 2010.doc 3

that apparently is threatening to devour us all. It also has not worked to drive down the value of the
dollar in foreign exchange markets. While most people would consider a strong currency as a plus,
our government and central bankers seem convinced that the only way to work our way out of our
huge trade deficit is to manage a decline in the dollar. This worked for a couple of months until the
European financial crisis and signs of an economic revival drove the dollar back up. Programs like
QE II only work if everybody reacts exactly the way the program designers expect. And in this
complicated world of ours, that doesn’t happen very often.

We’ll leave this section on a positive note

Retail Sales
– early indications on holiday spending % Change Prior Mo. Seasonally Adjusted
Source: U.S. Census Bureau
are that the mojo is back, baby.
2.5%
November retail sales increased 0.8% over 2.0%
1.7%
prior month, 1.2% if you exclude auto 1.5% 1.2%
0.9% 1.0% 0.9% 0.8% 0.8% 0.8%
sales (a rather bizarre result, since auto 1.0% 0.5% 0.3%
sales in November were actually okay.) 0.5% 0.0%
0.0%

October results were also revised sharply -0.5%

-0.3%
higher. Strength was pretty much across -1.0%
the board except for things like furniture -1.5%
and electronics, reflecting the weak -2.0% Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10
housing market and the fact that even Total less Autos
Total Retail
American males can only watch so many
big screen TVs at the same time. Anecdotally, Zoobles (you’ll just have to read last month’s report)
are blowing the doors off – the Wall Street Journal reports that the manufacturer is making one
million Zoobles per month and can’t keep up with demand. We believe this reflects well on the
Zooble marketing plan and poorly on the state of the American educational system. In China, the
kids are busy studying math (they ranked number one in a recent global test) so that they can do a
better job making Zoobles to ship to American kids so that they can stare at them instead of doing
their math homework (we ranked down in the teens somewhere). At least we’ll be entertained as we
slouch towards Armageddon. One other interesting aspect of the retail report is that non-store (on
line) retailers continue to eat big chunks of bricks and mortar market share. Through eleven months
of 2010, non-store retailers’ sales increased over 13% from prior year and the sector, in aggregate, is
now larger than the retail furniture, electronics and sporting goods sectors combined.

Economic Trends December 2010.doc 4