The Reuters-Michigan survey of consumer sentiment registered a decline from 77.5 in February to a preliminary reading of 68.2 in March. That’s the biggest monthly decline since the financial crisis in October 2008, and wipes out the nice gains of the last four months to put us back where we were in October 2010.
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I noted a few weeks ago that the lost consumer purchasing power from the oil price increases seen so far could subtract 1/2 percent from GDP. Consumer sentiment is not the most important economic indicator, but it does seem to be one factor in why spending sometimes responds by more than the simple calculation behind that 1/2 percent figure would suggest. The connection between gasoline prices and consumer sentiment is pretty well established. A recent study by Paul Edelstein and Lutz Kilian (published version here, working paper here) estimated the following relationship over 1970-2006 of how consumer sentiment declines after an increase in energy prices.
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We had been getting some good economic news on other fronts lately, which I had been hoping would be enough to offset the hit to consumers’ budgets from energy prices. The March numbers so far are just preliminary, and consumer sentiment is a somewhat noisy indicator. But whatever you make of the latest report, it is not good news.
Another question asked in the survey pertains to expectations of inflation. Consumer expectations of inflation for the next year jumped from 3.4% to 4.6%. Again gasoline prices seem to figure more prominently in consumers’ expectations than we might have expected, and again we can do a simple mechanical calculation of the direct effect. Gasoline prices have a weight of about 5% in the CPI, so if all other prices were held fixed, the 20% increase in gasoline prices we’ve seen over the last 3 months would add about one percentage point to the CPI.
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The Fed tends to focus on core inflation rather than the headline inflation, in the belief that the energy price hikes won’t continue and are not themselves reflecting U.S. monetary policy. I’ll leave both those issues for future discussion, and confine myself here to the observation that the nature of the shock we’ve seen is stagflationary, simultaneously reducing expected real GDP growth and increasing expected headline inflation. The magnitudes may be modest– perhaps a single percentage point for each. And although the Fed had been wanting to see a slightly higher inflation rate, I do not believe the form in which the news is coming is altogether welcome.
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Nice understatement in the last line.
There’s also the low-to-medium strength correlation between today’s average gas prices and what the unemployment rate may well be two years from now. Today’s high prices at the pump are pretty close to the cusp of suggesting that we’ll be seeing an upward trend in the unemployment rate in the 2012-13 timeframe.
Bill Dudley: Let them eat iPads!
This dismal science stuff is all very depressing. I’m looking forward to your annual NCAA bracketology post.
And over the last 10 years there has been a unquestionable long term stickiness to headline CPI despite the usual short term volatility. The trend is a moderate rise in headline CPI inflation relative to core. This is not to suggest that core inflation does not remain very important, but that headline inflation, because of energy and it’s long term prospects, deserves serious attention.
This is a very nice analysis. It is interesting to see the persistence and magnitude of the effect of an oil price increase on consumer confidence.
I am not convinced that increased oil prices necessarily lead to inflation. However, they will tend to dampen economic activity, which will tend to encourage the Federal Reserve to respond with easy money to support aggregate demand. Notwithstanding, easy money cannot compensate for a real price shock, as the experience of Arthur Burns in the 1970s shows–or at least, that’s my take.
I think it may be time to re-visit the inflation question. Here’s an interesting article related to the topic from the WSJ:
http://blogs.wsj.com/economics/2011/03/11/ny-fed-chiefs-ipad-2-comment-irks-queens-audience/
Please note gentlemen, that the US has never experienced oil consumption/private GDP at 7%+ with the 10-yr. avg. change of real per capita private GDP and industrial production having turned negative.
“This time is different”, and not in a good way . . .
With peak global oil production having occurred in ’05-’08, it is mathematically and thermodynamically impossible for global real per capita private GDP to avoid contraction, let alone growth.
The Japan quake and tsunami will send ripples through the regional and global production chain, reducing real GDP growth hereafter.
Note that after the Kobe quake in ’95, oil was below $20/bbl, Japan’s public debt/GDP was one-third today’s level (200% and climbing today), and Japan’s public debt/GDP was 40% of today’s level.
Japan cannot afford to rebuild AND maintain real per capita GDP, even with a declining population. The larger structural effects of this reality will be but one of dozens of examples of the prohibitive costs of Peak Oil and population overshoot.
For China to continue 10% growth, China will have to double the money supply in 30-36 months and thereafter double it every 14-16 months; this will not happen. The Japan quake/tsunami will be the coincide precipitant, not cause, of The China Crash, taking the rest of Asia and the world with it.
If you have not sold China and emerging markets, and have yet to give up on the “Decoupling 2.0” story, you are out just about out of time to do so.
Sell stocks and prepare for the largest, most-protracted global stock bear market and financial and economic crisis in world history.
The “Greater Depression” begins now.
The predictability of models is no longer, what it used to be (courtesy of the long lasting prices distortion). Ironman model has been quiet consistent and yet the finesse is in the evaluation of the probability of occurrence of an event.They tend to be less reliable as witnessed through the Fed NY probability of recession as predicted by treasury spread.The timing is more coincident than leading.
http://www.newyorkfed.org/research/capital_markets/Prob_Rec.pdf
All agree recession probability is low, then what would disturb the yields curves?
The risks premia?,they are no risks.
Inflation? the expectations are well monitored.
To be noticed the ADS business indicator is flattening around neutral.
Fully agree with the conclusions of prof. Hamilton in this one. Finally the inflation threat in the USA becomes visible for everyone. And, since its driven by imported oil, QE and fiscal deficits are meaningless. Oil supply security is where money must be invested- either home drilling, or military operations abroad ( start with Libya, next week?)
Nemesis:
“largest, most-protracted global stock bear market and financial and economic crisis in world history. ”
I am not sure about the largest, but most protracted it will be.And in the end, if people do not turn wiser, it may be also the largest, but that is at least 30-40 years off until China catches up with NATO militarily. Things do not have the same amplitude as earlier, but time wise they are stretched due to increased amount of information and perceived corrective actions-which protract the crisis.
With occasional small bull markets in between, lasting sometimes even few years.
This is off topic but I can’t help but notice that that map is an approximation of red state- blue state. It appears that gas prices are higher in areas that tend to be liberal, lower in conservative.
@Nemesis:
It seems to me you have a kind of wave theory of economics in which all interactions tend to, inexorably, amplify the wave. Don’t you think, for instance, that lower output growth rates in China may have positive effects elsewere?
Nemesis, great piece there. I believe what you said, I saw this coming for a while and the quake disaster will only speed it up.
I am loading up on GOLD and playing low cap stocks with low risks.
Michael Haley: Note that these prices include taxes, which differ significantly across states.
Varying State gasoline taxes probably explain at least half of the differences between states. Higher property taxes in certain States also plays some role. So the red/blue idea is not entirely unexpected.
Consumer sentiment falling? So? An “economy” that depends on people thinking happy thoughts is not an economy I care about. Anyone who believes that people need to think happy thoughts for there to be a good economy is not worth listening to.
I took the graphs of PM futures in this post to mean that PM investors expect a recession next year.
Usable metals expected to fall, useless gold still expected to rise.
I don’t value the opinion of goldbugs much, but I’m not willing to dismiss this.
JDH: “I do not believe the form in which the news is coming is altogether welcome”
I.e. exogenously generated adverse inflation shocks as opposed to endogenously generated inflation reflecting economic growth?
Non-Discretionary Expenditure as a Percentage of Disposable Income with personal savings as a percentage of NDE, through 2010.
NDE still hasn’t fallen below 50% of DI and it is increasing again. Gas was not quite at 2008 levels yet in Dec, but healthcare more than made up for the slight drop in Financial Services expenses, so gas prices probably don’t need to get that high for trouble, either nominaly or as a share of DI.
Steve, I think it leads to headline inflation, but core deflation. Core deflation could be large enough that headline itself could fall.
“America’s poorer families are suffering more than richer households as they face a bigger squeeze from the highest gasoline expenses in more than two years, stagnating wages and a jobless rate that has remained at or above 8.9 percent since April 2009. Their pain is shared by their preferred retailers, including Wal-Mart Stores Inc. (WMT) and J.C. Penney Co.
“Rising gas prices and still-high unemployment levels weigh on the minds of our customers,” Bill Simon, U.S. chief executive officer of Bentonville, Arkansas-based Wal-Mart, said on a Feb. 22 earnings call. “Pressure from higher energy and commodity costs are factors that we will watch closely, as they affect our own logistics and transportation costs, as well as the prices the customer pays,” he said. ”
From Bloomberg.
Let’s add some sunshine to this. The personal debt of Americans continues to decline as they prepare for the next phase of the greater depression. We are headed to barter and hard asset use for most financial transactions in the next 5 to 10 years. As some of you know, I have been working hard to become totally debt free by mid-next year (2012). It looks like a great many more Americans are doing the same thing.
Ignacio,
China’s money supply has been growing at a hyperinflationary Third World rate since ’05-’08, and fixed investment/GDP is unprecedented. China will not just slow and attenuate demand and price effects elsewhere. China is set to crash and experience no further growth in real per capita GDP hereafter.
Peak Oil and population overshoot means that the cost of energy extraction, processing, transport, storage, distribution, and reinvestment will continue to rise; that is, the declining net energy effects of diminishing returns to energy to obtain energy will render impossible further expansion of debt money and gov’t spending, and thus result in an inexorable decline in per capita liquid fossil fuel energy supply/consumption and real GDP hereafter.
China will crash because of a permanent decline in net energy returns and global real per capita GDP, which is to say a permanent relative increase in per capita net energy costs to sustain the impossibly complex global energy and goods production system.
There is no viable intermediate-term solution except to adapt as quickly as possible to producing and consuming less hereafter.
But it is already about 20-30 years too late to build out an “alternative” energy infrastructure, as we will need 70-75% of the existing liquid fossil fuel energy supply and 20-30 years to accomplish it; and we would still require a dramatic reduction in liquid fossil fuel consumption in any event in order to free up supplies to build out the “alternative” infrastructure.
But one cannot build and maintain replacement investment for solar panels, windmills, and electric vehicles using solar panels and windmills, as the full-spectrum net energy density of “alternatives” is woefully insufficient compared to crude oil and condensates.
Finally, the more complex the energy and connectivity requirements for our fossil fuel-dense, techno-economic civilization, the higher the incremental costs and scalar effects of increasing entropy and falling net energy returns, particularly at increasing distances per capita.
Yet, over the past 20-30 years we did just the opposite of what the Earth’s thermodynamic limit bound implied was most prudent and sustainable. Rather than recapitalize “local” efficiencies of scale and exchange, we expanded beyond localities and regions at increasing distances for supply chains at fixed costs of production, communications, and transportation infrastructure well beyond local means to support the infrastructure.
Now the human species, having far surpassed carrying capacity, has become alarmingly vulnerable to myriad risks of supply disruptions for energy and food, which further risks the sustainability and viability of the highly complex higher-order services sector (gov’t, telecommunications, transportation, etc.) on which the majority of the West’s populations rely for employment and the functioning of the society.
Capitalism (as we currently perceive it) and “globalization” (Anglo-American imperial trade regime) were artifacts of cheap and abundant liquid fossil fuel supplies, but that era is over, which implies that capitalism and “globalization” are likewise coming to a close. The question is how to avoid (or hasten along) a neo-feudal dark age.
Nemesis,
I was with you, until the asault on Capitalism. I am still are big believer in humans coming up with the necessary ability to both feed, cloth and house themselves. We do stand at a very stark point when choices of the existential type must be made. However, the amount of solar power generation in the U.S. is doubling every two years. If this continues, the U.S. will be able to meet it’s entire requirements within the next ten years. Then of course there is will, water and natural gas, as well as residual oil and coal. The sun provides on a daily basis 10,000 times that necessary to meet our needs. On the food side, we have quintupled our grain BPA since 1900. We are on the cusp of some very wonderful times. I am very much a contrarian, so when times are tough, if you dig in and do the right things there will be a better day. Most of our issues are political, social and monetary.
steve, total cost is the point most of the techno-optimists miss, and it is profoundly important to understand net energy returns, which virtually no one does (or won’t admit publicly because it is not a good career move).
Wait until solar surpasses the “takeoff” stage and reaches or approaches the “growth boom” stage of the techno-economic S-curve trajectory. The optimists are looking primarily at the number of panels, cost per panel, and efficiencies in electricity output. Total net energy costs of “alternatives”, INCLUDING total system net energy liquid fossil fuel costs, will result in the EROI for solar, wind, etc., to PLUNGE, especially on a real per capita basis.
US crude production has fallen per capita 3.2%/yr. since the secondary peak in ’85, whereas per capita debt/GDP, debt/income, and debt/energy unit ROI have SOARED at a net rate to per capita crude production deficit of ~7%, resulting in net energy return to debt over the past quarter-century falling 60%.
IOW, we have 150% more debt to GDP and available net energy. There is no way mathematically or thermodynamically we can sustain the public and private debt service, maintain the necessary scale of existing liquid fossil fuel infrastructure to keep the economy going in the meantime, AND find the necessary incremental net savings, capital investment, and affordable energy and materials to build anything close to what you describe; and especially not to the scale necessary to accomplish what you think is possible.
Just do the simple algebra. We would need net energy returns to the TOTAL SYSTEM of 11% at 4% nominal GDP to provide surplus savings/capital to build out “alternatives” to scale, and we are at NEGATIVE 7% per capita.
We have monetized and borrowed 7%/yr. net against future savings and investment via imported oil and offshoring goods production and productive capital stock, meaning we have barely 20% of the necessary capital stock today just to replenish the existing stock in net energy per capita terms. Just to keep the net energy per capita returns constant, we have to reduce net energy consumption at the per capita rate for a half-century.
The faster we ramp up the scale for solar and wind, the sooner it will be inescapable that the system net energy returns per capita are declining (costs are rising faster than returns), and at some point will plunge as a growing share of constrained liquid fossil fuel net energy is taken away from transportation, food production and processing, distribution, etc.
Perhaps you are not aware, but 10-yr. avg. US real private GDP per capita has begun to contract, which did not even happen in the Great Depression when oil was well below $20 in inflation-adjusted terms.
IOW, we have reached the limits of growth of gov’t, debt-money, and real private per capita US output. We are now forced to “consume” existing financial and physical capital stock for years ahead. There will be no net new capital to invest in “alternatives”.
One of the most-cited alternatives/renewables study done to date did not even examine the net energy costs over the 20-30 years the study’s authors used as the timeline to build out the infrastructure. This is ASTOUNDING!!! They presented only the data on the incremental costs of the technology and its output and savings in fossil fuel consumption terms but said not a word about the total system “net energy” costs or EROEI of the build-out.
When the falling system net energy returns (rising costs) are taken into account over the next 25-50 years, especially at the price of oil above $40-$60 that will not allow for real per capita GDP growth, the net energy returns per capita from the alternatives infrastructure collapses long before the “growth boom” phase of the S-curve gets underway.
Electric cars (EVs) are NOT THE FUTURE; the technology is 120 years old, and the net energy costs of scale to replace even a tiny fraction of the ICE fleet in the US and elsewhere will be prohibitive. We will be walking and bicycling more miles in the decades ahead than we will log behind the wheels of EVs.
I invite you to be much more discerning about the techno-optimists’ self-serving perspective and examine more closely the total system net energy returns/costs. You will be one of a small pct. of interested observers who has actually taken the time to be fully informed.
It might be discouraging when the realization strikes you, but at least you will thereafter be compelled to apply your intellectual energies toward adaptation and resilience instead of impractical, costly, techno-utopian boondoggles as “alternatives”.
Nemesis:
Yes, saving any energy is the only long term good investment. ( e.g. extra-insulate houses). The higher the oil price, the better the return and faster payback time. No big investments in production, a lot of local manpower required to perform residential improvements, a lot can by done by residents themselves.
Dr. Hamilton,
You know what would be interesting to look is the difference between core and healine vs. core and also core in following months.
Do increases in headline push down core?
I’d be interested to hear Dr. Hamilton’s take on which of the economic releases have the most crucial weighting on the markets. Obviously big FOMC announcements cause big ripples, but from your vast experience with the economics and the markets, which indicators do you feel outweigh others in terms of actually affecting the markets?
Matt
Matt: See Calculated Risk.