Friday, June 25, 2010

The iPad Economy

I love the iPad. It's great. But its huge success - 3 million sold in 80 days - doesn't represent a huge success for the average American. The news media just doesn't get it, so there is no chance for the American public to understand what is about to happen.

Back in April we treated to news stories about the first quarter growth in the Gross Domestic Product. And example is this one in the LA Times written by one of its own reporters headlined Nation's GDP grows at 3.2% rate in first quarter which told us:
The economy grew 3.2% in the first quarter of the year, the Commerce Department reported Friday, another indication a steady, though modest, recovery has taken hold.
The annualized rate of growth of the gross domestic product -- the nation's total production of goods and services -- was down from the 5.6% rate of the last three months of 2009. But that had been expected as the effect of the federal government's stimulus policies peaked during that period.
..."We're still running on the fumes of stimulus in the U.S. economy," said Diane Swonk, chief economist at Mesirow Financial in Chicago. "It's a recovery, but by any standard is still a muted recovery. But we're thankful to have what we've got," given the depth of the recession, she said.
..."I think its well in line with expectations," Swonk said of the first-quarter figure. "The recovery's more broad-based. Although the momentum slowed quite a bit from the fourth quarter, the consumer showed up and we had a lot of demand, which is good."

Except that today the LA Times offers a followup wire service story headlined Government lowers 1st quarter growth estimate that reports "Gross domestic product rose by an annual rate of 2.7 percent in the January-to-March period, the Commerce Department said Friday."

The article does ramble through some information. But it doesn't explain why the growth number was dropped 15.7% from the original estimate. Nor does it point out that the GDP grew less than the population - in other words, the per capita GDP is still a negative number. Nor does it note that the growth rate would have to be above 3.5% the rest of the year to meet the Federal Reserve's forecast for a start to an economic recovery.

That forecast coming to fruition doesn't seem very likely since:
  • retail sales in May fell for the first time in 8 months;
  • new home sales plunged 33% in May because the tax incentive stimulus expired in April;
  • the Republicans in the Senate killed the jobless bill which means that unemployment insurance will disappear for about 200,000 unemployed people each week for the foreseeable future;
  • state government, school, and local government spending will dramatically drop over the next 12 months, particularly without the funds that were in the jobless bill.
All of which brings me to the iPad economy. It is possible that sales of the iPad and the iPhone 4 could effectively distort the second quarter results. What's bad about that is the hidden truth of our economy, which the iPad as a product represents.

It is possible that during the April-June 2010 quarter American consumers will have spent $3 billion purchasing iPads and iPhones. That is very different than spending $3 billion on purchasing homes or even cars. The difference is that the multiplier effect of the $3 billion in purchases of Apple products won't be comparable. Nothing in the iPad is manufactured in the United States.

A home is constructed by American workers and the products and many of materials used in the home are manufactured here using raw materials from here. Each dollar spent multiplies in our GDP.

Sure, Apple in America employs the folks who develop a product like the iPad and sure a number of other companies and individuals will add to our GDP developing and selling accessories and apps.

But to be enthused about consumer spending growth as one might be if new home sales jump is not possible. When Apple turns on the production line, it is all in the ether of computerized accounting for Americans, it is money going to China and Chinese workers, it can be seen on the screen but not felt.

That is why people are failing to understand the truth of the report that also came out today telling us that corporate profits increased 8 percent in the first quarter and earnings were up 34 percent from the same time last year. In an iPad economy these numbers can never translate into a corresponding increase in employment. Nor does it mean that the federal state, school, and local government revenues will see a corresponding increase.

When something was designed and manufactured in the United States using materials mostly from the United States, every dollar spent by a consumer to acquire the item was multiplied in our economy. Not only did the store clerk get a piece of the dollar the consumer paid for an RCA TV in 1952, the American who made the cabinet for an RCA TV in 1952 got a piece of the dollar. So the dollar spent, plus all the pieces as they passed through various hands in the system, increased the GDP and became taxable income which helped to support the school the consumer's kids went to.

When I bought an iPad, the employee who made the metal back got a piece of my purchase price, but he or she is in China. My consumer spending just isn't comparable as a stimulus to the American economy as one might think. It most certain isn't comparable to spending on new home purchases.

The hard truth is the U.S. has reached a limit. We as consumers can't spend our way out of The Great Recession. We must start producing things here beginning with the raw materials, to the extent possible, and ending with the final product. And we need to find a way to represent our economy so that a dollar spent on an iPad purchase is not equated by economists and the media to a dollar spent on a new home purchase.

Thursday, June 24, 2010

The Great California Slump: Phase 2

In May 2009 I wrote:

California's Great Recession likely will begin "in earnest" in July 2009. And unfortunately for the Obama Administration and the world, what was the world's 8th largest economy will drag everyone else down with it.

It was in a July 2009 post that I suggested calling it "The Great California Slump" in recognition of the fact that California has its own economy, simultaneously integral to and separate from the U.S. economy.

The fact that seems hard to grasp is that the employment level in California is the same today as it was in the period from 2000-2002. In my opinion it will remain at that level through 2015. California is in a depression comparable to that of the mid-1930's.

The only difference is that a "safety net" of extended unemployment insurance and other economic subsidies reduced the immediate impact on individuals. Also federal "stimulus" programs such as the August 2009 "Cash for Clunkers" program and the home buyer's tax credit slowed the overall economic slump.

But we are now seeing a fear of deficit at the federal level that apparently will result in many of the programs ceasing which will further depress the California economy. One shouldn't underestimate the impact these programs had.

For instance, the home buyer's credit expired in April. This week a news article headlined New-home sales plunge 33 pct with tax credits gone reported:

Sales of new homes collapsed in May, sinking 33 percent to the lowest level on record as potential buyers stopped shopping for homes once they could no longer receive government tax credits.

...Analysts were startled by the depth of the sales drop.

"We all knew there would be a housing hangover from the expiration of the tax credit," wrote Mike Larson, real estate and interest rate analyst at Weiss Research. "But this decline takes your breath away."

Reporting on the same data, the Los Angeles Times noted: "Sales in the West were down by more than half."

And now comes The Great California Slump: Phase 2. Consider this comment by UC Berkeley business school dean Laura Tyson, a top economic official in the Clinton administration who is on the short list to become President Obama's budget czar:

Deep cutbacks by state governments such as California have all but obliterated the effect of the nearly $800 billion federal stimulus enacted last year....

As I noted in May 2009:

As the State reduces its purchases of supplies, equipment, and services from the private sector and starts laying off employees whose families stop spending, the multiplier effect will put more private sector workers on the unemployment roles. This will result in reduced sales tax and income tax revenue which will increase the State budget deficit.

What has happened is that the government of the State of California has hit a brick wall because it is now clear there isn't enough money flowing in the economy. As noted by one observer:

The governor has a state budget that his fellow Republicans more or less support. Assembly Democrats have a budget whose centerpiece is a complex scheme to borrow billions of dollars. And Democratic senators have a budget that's based on raising taxes and shifting some programs from the state to counties.

...The two Democratic versions of the budget are very much at odds, even if they both agree on rejecting Gov. Arnold Schwarzenegger's slash-and-burn approach to closing a $19.1 billion deficit.

Moreover, Attorney General Jerry Brown, the Democratic candidate for governor, has declared that the massive borrowing envisioned in the Assembly plan probably would violate a 2004 balanced-budget ballot measure.

It is easy to blame ineffective and irresponsible government. But even when I'm doing so, I am fully aware of something recently noted by another observer explaining a recent study:

In the paper, Inman tests factors in states' budgeting practices, politics and economies in order to figure out which correlates most heavily with their economic conditions. The runaway winner is unemployment. "States with a one standard deviation higher rate of unemployment (10.0%) will have a budget gap which is $222/person more than a comparable state with an unemployment rate one standard deviation lower than average (6%)," he concludes. Inman finds this to be a cheering prospect: "The good news from this analysis is that the states’ fiscal crises of 2009 do not appear to be linked to any obvious structural or institutional failures in state finances. It’s the economy."

A few other points from the paper: The states that have survived the recession best are not states with more competent governments. They're states that depend on natural resources – Montana, Nebraska, North Dakota, Texas, West Virginia, and Wyoming – for revenue. Budget cuts, as you might have expected, have hit aid to local education and transfers and services for lower income families hardest. And the stimulus covered, at most, 23 cents of each dollar of state budget gap -- and that's running out this year.

In other words, it may be fun to denigrate our politicians or to point to states that seemingly do it better because they have a different tax structure, but the fact is the more a state and the local governments and schools in each state depend on income and sales taxes rather than income from taxes on natural resources and real property, the worse its budget problems.

Of course, our politicians are deserving of criticism.

Confronted with the current situation, the Legislature didn't even try to meet the June 15 budget deadline and the joint committee working on the budget adjourned for awhile because they can't figure out how much money they have to spend in the next six months.

Meanwhile, in March the Senate passed a proposal sponsored by California Forward that would require the governor to submit a two-year budget plan and a five-year fiscal outlook to the Legislature in odd-numbered years beginning next year.

Really? The Legislature and the Governor have been adopting and significantly revising the state budget every six months for several years now, but someone thinks they can adopt a two-year budget and make serious five-year fiscal projections.

I know, I know, we need all those great business planning practices that will avoid the problems.

But who, again, was the person who in early 2006 offered the projection that in 2009-10 taxable sales would be 16%+ lower than in fiscal year 2006-07, taxable
personal income would be 20%± lower than it was in 2006-07, and the Corporation Tax income would be 17%± lower than it was in 2006-07? If no one would have put that in the five year plan, doing the plan would have been an exercise in futility. Worse yet, if the Governor had put that in the plan, he would have ceased to perform a critical role for the State - head cheerleader for our economic outlook.

The Great California Slump: Phase 2 is going to be a worsening of the economy combined with a weakening of the "safety net" at both the federal and state level. And California is not alone. Here's a map of the states this year showing those with deficits in red, the darker the red the worse the problem:

The federal government does need to recognize the depth of the problem. California, New york, Illinois and New Jersey, the four darkest on this map, contain 25% of the nation's population. If you add in the next tier, Florida, Pennsylvania, New Jersey, Washington, Arizona, and Connecticut, 43.5% of the American population located in 10 states will be seeing major cuts in state, local government, and school employment and purchasing and/or tax increases beginning July 1.

This will severely impair any national economic recovery, perhaps delaying a recovery for a decade. And it could cause significant numbers of Americans to experience economic stress not seen in this country for 80 years.

In any event, absent some remarkable strategy implemented in the next three months The Great California Slump: Phase 2 is about to begin.

From an AP news article on line as of around 8 pm EDT tonight headlined Republicans kill Senate jobless aid measure:

The rejected bill would also have provided $16 billion in new aid to states, preserving the jobs of thousands of state and local government workers and providing what White House officials called an insurance policy against a double-dip recession....

The demise of the bill means that unemployment benefits will phase out for more than 200,000 people a week. Governors who had been counting on federal aid will now have to consider a fresh round of budget cuts, tax hikes and layoffs of state workers.

Friday, June 11, 2010

The Evil Reality in the Magic Kingdom

As a government with serious responsibilities related to the well-being of its residents and visitors, the State of California has a twofold problem.

The first difficulty is that based on all available information the state's economy is essentially producing somewhere between 15% to 20% less wealth then it did in the period between July 2006 - June 2007. That was what I described as The Great California Slump last July and we know that a "recovery" will take a very long time. In the meantime, we read about the effects on our workers and families in stories like Jobless without a net , stories subtly warning us that the federal government will not be able to carry Californians through the slump.

The second difficulty is the resulting effect of The Great California Slump on state government revenues.
  • In fact, taxable sales are 16%+ lower than in 2006-07. Fortunately for governmental operations, in 2009 the legislature increased the sales tax rate from 5% to 6% - a 20% increase - so sales tax revenues are slightly higher than in 2006-07.
  • Though the numbers are harder to calculate, it appears taxable personal income is 20%± lower than it was in 2006-07 which is masked by a 2009 0.25% rate increase and a temporary 10% increase in withholding which makes it seem like income tax revenues have only dropped 7%.
  • The Corporation Tax income has dropped 17%±.
The Governor and the candidates for Governor, as explained in the last post, all operate in some Fantasyland where it is believed that the Governor has some powers - sort of magical pills - to reduce spending and make it all better. But, in fact, the pills have side effects that reduce revenue further, cause injuries to residents and visitors, and are simply illegal in some cases, as the Gubernator found out.

The Legislature operates in Tomorrowland - never do today what can be put off until tomorrow. In their case, for 2009-10 they "borrowed" money to avoid cutting expenditures, made one time accounting "adjustments" like moving the June 30, 2010 payroll to July 1, 2010 and what that didn't cover, they chose to budget revenues too high. So after waiting, we will learn in July that the 2009-10 Income, Sales, and Corporation taxes budget line items were in total 7% too high which amounts to about $6 billion.

What we know today about the fiscal year beginning July 1, 2010, is that nothing has changed for the better since the State's CFO, State Treasurer John Chiang, told a reporter that the State General Fund deficit could likely reach $35 billion. Since the total budgeted General Fund revenue last year was $89.5 billion, we're really discussing a potential 40% deficit. The Gubernator in January proposed a budget which was dead-on-arrival in the Legislature because of policy issues and is now dead because the numbers were from Fantasyland.

So far, as the 2010-11 fiscal year beginning approaches, Legislative leaders have proposed to borrow $9± billion to be repaid from beverage recycling fee revenue and to repay the recycling fund from a new tax on oil production, the latter being accomplished without a two-thirds vote by making various sales tax shifts! This was in response to the Gubernator proposing in the middle of The Great California Slump to eliminate medical care for the kids of the underemployed and unemployed whose jobs have disappeared in the past three years and for old people whose retirement nest egg went the way of the State's employees retirement funds.

And in the midst of most of the 58 Counties having to make unprecedented budget cuts for 2010-11 which will involve significant layoffs creating more unemployment, Legislative leaders and the Governor are discussing shifting welfare and prison costs to the counties offering meaningless promises to cover the costs which, of course, would be cheaper.

Let's take a look at the situation at the county level by sampling recent headlines:

Deep Cuts for Alameda County
31 Fresno County deputies let go in cuts
[Contra Costa] County budget proposal would slice $34.4 million
[Sonoma County] Social services brace for cuts
[Santa Clara County] Budget-related transit cutbacks take effect today
State cuts Humboldt County's victim witness support funds
S.F. home value drop, jobless drain city budget
L.A. County sheriff considers major budget cuts
LA County budget cuts to deprive seniors, disabled of homecare service

And to sample an article Yolo County budget includes less spending, more job cuts:

Yolo County has proposed a $271.5 million budget for fiscal year 2010-11, the third-consecutive budget with a dramatic decline in spending....

...Since the county’s largest-ever budget in fiscal year 2007-08, revenues and expenditures have dropped $38.3 million — or 9 percent — and 408 positions (24 percent) have been eliminated. The county’s ratio of employees per 1,000 residents is at the lowest level in more than 20 years.

Sure, why not pass down a few more responsibilities to the counties. Things are bound to improve.

After all, Treasurer Chiang issued a report for May this week indicating May revenues were looking better than estimated by the Gubernator in January just as we are told:

Retail sales in May took their biggest dive in eight months, raising fresh doubts about the state of the nation's recovery and the pace of long-term economic growth...

"Retailers have long recognized that it may be a long uphill climb to full recovery, but [Friday's] report suggests the climb may be steeper than we thought," said Sandy Kennedy, president of the Retail Industry Leaders Assn. "Until the overall economic news improves and those Americans out of work find employment, meaningful retail sales growth will be difficult to achieve."

So it is likely that June revenues, which include sales taxes paid to retailers in May, might not be so good.

Interestingly, to stimulate discussion Chiang included with his report a report on tax policy prepared by economists at the Milken Institute offering a recommendation to cut corporate taxes in the U.S. which could by 2019 "increase total employment by 2.13 million." Do these guys live in Fantasyland with the Gubernator? The U.S. economy lost 7.8 million jobs between November 2007 and April 2010 and we have a huge federal budget deficit, now, not in 2019.

If economists, the Legislature, and the Governor are lost is some fantasy of their own, it's no wonder that those involved in giving care to the poor and elderly, those teaching our children, those who offer "seed grant money" for new businesses under a state program, those who guard our prisoners, those who run our local governments, etc., all behave as if the problem isn't the economic collapse of the state but rather just unaware political leaders in Sacramento who control more than enough money to take care of everything.

Residing in the Magic Kingdom, the Governor and the Legislature both fantasized that the federal government would help. What we saw in the LA Times last week was this headline Congress pulls back state aid package, leaving a $2-billion hole in California budget. Oh well, a billion here, a billion there....

Within our Magic Kingdom an evil reality exists. The evil reality is the basic structure of our government which prevents any effective action that would begin to address the problems. Electing the folks now running for statewide or legislative office this November will not result in improving California government.

We need to replace the State Constitution. And maybe the only real solution, given the political divisions in the electorate, is to replace it with three state constitutions, one for each state created from the existing State of California as suggested here.