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Research Reports AMERICAN INSTITUTE for ECONOMIC RESEARCH www.aier.org Vol. LXXIX, No. 15, September 3, 2012

Globalization Pays Off Manufacturing flexes its muscles as foreign and domestic firms expand their U.S. operations.

by AIER Staff

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anufacturing, one of the hardest-hit sectors in the increases the attraction of America’s more productive laU.S. economy, has recently experienced a substanbor. More stringent environmental and safety regulations tial revival. Since late 2011, manufacturing employment in China are also increasing labor costs and encouraging has been growing fairly steadily at a rate of about 2 perbusinesses to move back to the U.S. cent per year. (See chart on page 2.) While this is hardly International and American companies alike are dazzling, it is the industry’s highest rate of growth in finding the U.S. more attractive because manufacturmore than a decade. ing here grants quick access to the massive U.S. marIt is also big news for a sector that lost about 2.5 million ket. It is much easier to cater to American customers jobs between January 2007 and January 2010, an 18.2 perif the products are made where they are sold. The cent decline. According to the latest available data from move shortens the supply chain, lowers shipping costs, the Bureau of Labor Staand reduces the time it tistics, 312,000 jobs remain Companies are finding the U.S. attractive takes goods to reach conunfilled in the industry. because manufacturing here grants quick sumers. (For a deeper Although the overall look at the motivations access to the massive U.S. market. unemployment rate of manufacturers operatstill tops 8 percent, the ing in the U.S., see the upsurge in manufacturing indicates a positive trend that Economic Bulletins of June and July 2011.) could absorb even more of the semi-skilled labor force.

Among the companies returning to the U.S. to build Domestic manufacturing is expanding. But reshoring new factories is Caterpillar, which for years built many and foreign factories moving to the U.S. are also part of of its giant earthmovers for the North American market the picture. in Japan.

Reshoring is the repatriation of jobs that U.S. firms The company’s new $200 million facility, which had formerly moved to other countries. In this reverse globalits grand opening late last month in Victoria, Tex., will ization, America isn’t losing manufacturing jobs to other take over that production. It will also take over similar countries—jobs are coming back. production from Caterpillar’s Aurora, Ill., plant, which According to a study by the Boston Consulting will now focus on other work. Caterpillar has already Group, by the year 2020, 10 to 30 percent of the goods hired 225 new employees and plans to employ about 800 that America now imports from China could be made at people once the new facility is fully operational. home. This would boost American output by $20 billion General Electric also has been following this path. to $55 billion a year. In the long term, this would mean a This year, for the first time since 1957, the company decrease in the unemployment rate. It could also decrease opened two new factories in Louisville, Ky., as part of an the trade deficit by reducing imports and increasing $800 million upgrade of its Appliance Park facility. The American exports. first is a water heater plant that will employ 400 people.

The chief reason American businesses in Asia are reThe second makes bottom freezer refrigerators and will turning is that wages are on the rise abroad, particularly support around 600 jobs, according to Kentucky’s Office in China. Even with higher wage rates in the U.S., this of Economic Development.

Inside this report Once considered recession-proof, nursing has experienced a glut that has left many recent graduates scrambling for jobs. The reason: The financial meltdown pushed some nurses back into the workforce and prevented others from retiring. Another shortage looms because of this. See back page.

Also With tax hikes on the horizon, it’s a good time to convert to a Roth IRA. See Ask the Expert.

Research Reports, September 3, 2012

Change in Manufacturing Employment (Year-to-Year Percent Change)

4% 2% 0% -2% -4% -6% -8% -10% -12% -14%

2000

2002

2004

2006

2008

2010

2012

Source: Federal Reserve Economic Data

The job numbers aren’t very high, especially when compared with the 23,000 people who worked at Appliance Park at its peak. But moves like these will add up if big companies like GE continue making bold decisions.

Whirlpool is among those companies. As a part of a four-year, $1 billion American investment campaign, the appliance maker decided to build a $200 million plant in Cleveland, Tenn., instead of sending the 1,500 jobs abroad.

Other companies such as Dow Chemical, NCR, Sauder Woodworking, and GF Agie Charmilles have all brought overseas production back to the U.S. market in the past three years.

Foreign firms have jumped on the bandwagon by expanding their production capacities through their U.S. subsidiaries. In 2011, about 5.3 million Americans worked for foreign firms in the U.S., including about 2 million manufacturing workers—roughly 17 percent of that sector’s workforce. The payroll was $409.7 billion, averaging $77,597 in total compensation per year per worker—about a third higher than the average compensation for workers in American-based firms.

In 2011, foreign firms in the U.S. reinvested more than $90 billion in profits, bought $1.8 trillion in goods from U.S. firms, and accounted for 14 percent of all the corporate taxes paid.

The tax consequences of manufacturing in the U.S. can be considerable, but that has not put off Japanese carmakers Toyota, Honda, and Nissan. Each has opened new factories in the U.S. and added extra shifts in existing plants, further helping revive the manufacturing sector.

Toyota invested millions of dollars in its U.S. factories this year instead of exporting from its factories in Japan. The tsunami in Japan and the floods in Thailand last year disrupted Toyota’s supply chain to the U.S. This reduced Toyota’s market share from 15.2 2

percent in 2010 to 12.6 percent in 2011. The appreciation of Japanese yen against U.S. dollars and the lower costs of shipping within the U.S. rather than from Japan also made it sensible for Toyota to invest in its American factories.

Determining whether domestic, foreign, or global firms operating here benefit the U.S. economy the most is increasingly difficult. The emergence of truly global companies has blurred the line between domestic and foreign firms. So-called foreign or global businesses manufacturing in the U.S. often build products with more U.S. content than domestic firms.

The two automobile brands with the most Americanmade content are Toyota and Honda. Toyota Camrys and Honda Accords, for example, are made with 80 percent American parts, while the Chevrolet Volt uses just 40 percent domestic components.

Other “American” cars, such as the Ford Fusion with 20 percent American parts, are assembled in Mexico.

Ford, like other manufacturers moving into Mexico and Canada, is taking advantage of globalization as spelled out by the North American Free Trade Agreement (NAFTA). Plants in some countries neighboring the U.S. have lower labor costs, but remain close to the U.S. market and U.S. suppliers. The purchase of U.S.-made parts to be assembled elsewhere in North America creates more domestic jobs.

Foreign, domestic, or global, the firms operating here provide employment to American workers. Dividends paid to foreign parent corporations are after U.S. taxes, and often the foreign parent corporations have U.S. shareholders. Transfer payments between parent corporations and subsidiaries made before taxes are carefully regulated.

The presence of foreign manufacturing firms in the U.S. also increases competition. This leads to innovations and improvements in the existing technologies and helps make prices lower. That’s ultimately favorable for the end users of the products—the consumers.

Not all industries are going to benefit from a return of manufacturing, according to study by the Boston Consulting Group. Some jobs won’t be coming back any time soon.

Industries that will mostly benefit from the current trend include machinery, computers and electronics, appliances and electrical equipment, fabricated metals, furniture, transportation goods, and plastic and rubber products. This accounts for almost 70 percent of the goods that America imports from China. Some products, most notably textiles and shoes, will continue to be less expensive to make in Asia.

In the long run, a strong resident manufacturing base of domestic, foreign, and global firms could help America regain its competitiveness in the international markets. The U.S. might once again emerge as a manufacturing powerhouse.

Research Reports, September 3, 2012

Raising Taxes Won’t Help

Ask the Expert

Whether or not higher rates are politically popular, they cannot solve the problem of the rising federal budget deficit.

26%

Federal Expenditure ↓

24%

Percent of GDP

22% 20% 18% 16%

Federal Receipts ↑ 14% 12% 1947

1956

1965

1974

1983

1992

2001

2010

Source: Bureau of Economic Analysis

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ederal tax revenues have averaged 19.6 percent of GDP since World War II. As the chart above shows, federal receipts broke the 20 percent ceiling only once, reaching 20.6 percent during the tech boom of 2000.

This has led many economists to argue that it is irresponsible for the U.S. to make long-term commitments to expenditure levels above about 20 percent of GDP. Nonetheless, government expenditure was 25.5 percent of GDP in 2011 and is projected to be more than 24 percent this year.

The 20 percent ceiling for government revenue holds despite a wide variation in tax rates. In the postwar period, the highest personal income tax rates have been as high as 92 percent and as low as 28 percent, while corporate tax rates have ranged from 35 to 53 percent.

This means that raising taxes to address mounting U.S. debt is not an option. While it may seem fair politically, it is unrealistic and counterproductive in practice.

At some point, apparently around 20 percent of GDP, increased tax rates are offset by shrinkage in the tax base.

Individuals and businesses postpone income, find tax shelters, move assets offshore, and hire armies of accountants and lawyers to protect their income.

Some even move to lower-tax countries. Higher taxes can also slow economic activity by reducing the personal rewards for working, innovating, and investing. If a 25 percent increase in the tax rate is met by a 25 percent decrease in whatever the government is taxing, the country does not gain tax dollars.

Higher taxes have succeeded in increasing government revenue in small, homogeneous countries such as Sweden and Finland. With the large, diverse, and often fractious population of the U.S., it just doesn’t work. The history of U.S. taxes and spending shows that once expenditures rise about 20 percent GDP, no level of taxing will pay for it.

—Julie Ni Zhu, Research Analyst Read more about the topics in this issue at

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or aier.

Timely Conversion

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oday’s lower income tax rates are set to expire in December, which makes this year a good time to convert a traditional IRA to a Roth IRA. With a traditional IRA, the IRA holder must begin withdrawing minimum distributions by no later than the age of 70 and a half. Those distributions are subject to income tax.

With a Roth IRA, withdrawals are not mandated and distributions are entirely free of income tax.

In addition, the IRA holder can bequeath a Roth IRA to whomever he or she chooses. That person also will not be required to pay income tax on withdrawals.

But remember that if you took a deduction, as most people do, when you invested in a traditional IRA, you are required to pay income taxes on all of the money that you convert into a Roth IRA. Converting an IRA is not an all or nothing action. You can choose to convert only a portion of your IRA. However, conversions in 2013 will likely be subject to more taxes. Now is the time.

For people who have seen a dip in the value of their traditional IRA because of the weakened economy, this may also be an opportune time to convert.

You’ll pay less in income taxes than you would if you waited until the value of the IRA increased.

As always, you should discuss any IRA conversion decisions with your financial adviser.

—Steven J.J. Weisman is a lawyer and author. His website is www.scamicide.com.

To submit questions for future columns, e-mail asktheexpert@aier.org. For guidance on specific situations, consult your lawyer or financial advisor.

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Research Reports, September 3, 2012

Nursing’s Ominous Glut In the aftermath of the meltdown, many older nurses kept working. This temporarily ended a shortage, but set up problems for the future.

by Sarah Todd, Editor

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ome of the problems plaguing today’s job market are notes, it’s likely that many returned to work to help support unique to recessions brought on by financial meltfamilies impacted by recessionary troubles. The study’s audowns. In a typical recession, people may lose their jobs, thors say that the unusual influx of experienced nurses into but their assets stay relatively safe. But when the stock the workforce effectively ended the nursing shortage. market and the housing market collapsed during the Further exacerbating the problem for new graduates 2007-2009 recession, the net worth of the American family was the cost of hiring them. Hospitals pay $96,595 to at the median income level fell nearly 40 percent. Without interview, hire, and train each graduate RN, according to nest eggs to fall back on, many Americans nearing retireJean Arnold, director of nursing recruitment at a hospital ment stayed on the job. Others returned to work. The in Port Jefferson, NY. That’s a lot of money any time, let generation now entering the workforce faces a bottleneck. alone during a recession. Hospital revenues fell during the The fallout is readily identifiable in the predicament of downturn and its aftermath as unpaid medical bills went recent nursing graduates. For decades, nursing was considup and charitable donations and inpatient admissions ered a safe profession and a seller’s market for new grads. went down. Many hospitals had to rein in costs, leaving Registered nurses could expect to graduate with multiple entry-level nursing positions vulnerable to cutbacks. job offers in hand—not to mention signing bonuses and While these problems are likely temporary, they can student loan payoff programs that sweetened the deal. have long-lasting impacts for recent nursing graduates.

Even during the throes of the downturn, employment in Without current experience, their skills depreciate. If health care was relatively they can’t find nursing Exacerbating the problem for new RNs was jobs, they may have to stable. (See Business-Cycle Conditions, January 2012.) careers. the cost of hiring. Entry-level positions switch But according to the a That’s bad news for were vulnerable to hospital cutbacks. survey of 3,733 nursing everyone. The rapidly aggraduates from the class ing population, and the 32 of 2011, more than a third—36 percent—remained unemmillion Americans slated to gain access to health care unployed in September, months after graduation. der Obamacare, will soon heighten demand for nurses.

The results reported by the National Student Nurses Meanwhile, many nurses will leave their positions as the Association were actually an improvement over the preeconomy improves. According to a 2011 survey from vious two years. In 2010, the NSNA found that 44 perAMN Healthcare, a healthcare staffing company, 32 cent of new RNs were unemployed; in 2009, 46 percent percent of nurses plan to retire, change professions, or did not have jobs. In all three years, nurses cited a lack of reduce their workloads in the next one to three years. entry-level jobs in their area as the number one cause for This means that another nursing shortage may be their unemployment. Compare that to September 2008, around the bend. A similar problem may apply to public after the recession’s start, but before new RNs began to safety workers, teachers, and other professions hit hard feel its effects. Back then, just 23 percent of recent graduby the recession. As the economy recovers, they will be ates were unemployed. Of that group, less than a quarter needed—and perhaps long gone. reported that a lack of jobs in their area was the problem.

The employment landscape changed as older nurses gold corner saw the value of their IRAs, 401(k)s, and home equity go 1,900 into a tailspin. According to a 2011 Fidelity Investments survey, 49 percent of nurses changed their retirement 1,800 $1,660.50 1,700 plans because of the economy, with more than a quarter delaying retirement.

1,600 In addition, a flood of experienced nurses chose to 1,500 re-enter the workforce, according to a study in Nursing Eco1,400 nomics. Of the 250,000 RNs hired between 2006 and 2008— the majority of whom were brought on after the onset of 1,300 2011 2011 2012 2012 the recession—more than 40 percent were age 50 or above.

Price of gold, August 30, 2012, London PM fix.

Since seven out of 10 RNs are married women, the study 4

Research Reports (ISSN 0034–5407) (USPS 311–190) is published twice a month (except for combined issues in January and August) at Great Barrington, Massachusetts 01230 by American Institute for Economic Research, a nonprofit, scientific, educational, and charitable or­ganization. Periodical postage paid at Great Barrington, Massachusetts and additional offices. Donate now at aier.org. POSTMASTER: Send address changes to Research Reports, American Institute for Economic Research, Great Barrington, Massachusetts 01230.

Everyday Price Index, November 2012 AMERICAN INSTITUTE for ECONOMIC RESEARCH • www.aier.org • November 21, 2012

Everyday Prices Dip in October Thanks to falling prices for household fuels, gasoline, and recreation, the EPI ticked downward last month. But that’s not enough to reverse the climb of everyday prices over the last 12 months.

by Julie Ni Zhu, Research Analyst, and Sarah Todd, Editor

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rices of frequently purchased goods and services dropped 0.6 percent in October, according to AIER’s proprietary Everyday Price Index (EPI). This downward adjustment follows a 1 percent increase in everyday prices in September.

The EPI is based on the same survey data that the U.S. Bureau of Labor Statistics uses to create the Consumer Price Index (CPI). But the indices differ in several ways. The EPI is comprised exclusively of day-to-day purchases such as groceries and telephone bills, eliminating major purchases like cars and contractually fixed items like mortgages. In order to better reflect the outof-pocket prices that consumers experience, the EPI does not seasonally adjust prices.

The EPI’s October drop can be explained by price declines in three categories that make up a large part of the average American’s daily expenditures: household fuels, motor vehicle fuels, and recreation.

The household fuels, utilities, and supplies price index fell 1.74 percent in October. Electricity prices declined 4 percent because of seasonal changes. These large drops were somewhat offset by prices of fuel oil and natural gas, which are still trending up.

Motor fuel and transportation prices dropped 1.35 percent in October, thanks to a 2.1 percent decrease in the

price of gasoline. Gasoline has been particularly volatile in the past few months: This month’s decrease followed a 4.1 percent increase in September.

Several economic factors signal that these prices are likely to decline further in the near future. First, the manufacturing industry, which is the engine of the recovery, has weakened over the last few months. Second, many analysts expect sluggish economic growth in the first few months of 2013. All this may lower the demand relative to an ample oil supply. Meanwhile, spot prices for Brent crude oil dropped 2.4 percent to $109.89 per barrel in October.

Recreation services decreased 0.21 percent in October.

This change can be attributed to prices for cable and satellite television and radio, which fell 0.72 percent. Audio discs and tapes experienced a 1.31 percent increase.

The EPI’s biggest price increase in October was in the food and beverages category, which climbed 0.23 percent. Since average urban consumers spend about 39 percent of their daily expenses on food and beverages, even smaller increases make a difference in monthly budgets. The increase was mostly because of higher grocery prices, which rose 0.36 percent from September.

The prices of food served away from home grew just 0.07 percent. This means that restaurants didn’t change their prices much, while grocery stores did.

The Inflation We Feel vs. The Inflation Reported EPI vs. seasonally adjusted CPI (monthly percent change)

3.0%

EPI

2.5% 2.0%

CPI

1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% Oct

Nov Dec 2010

Jan

Feb

Mar

Apr

May

Jun

Jul Aug 2011

Sep

Oct

Nov

Dec

Jan

The EPI is a proprietary index of AIER. The CPI is produced by the Bureau of Labor Statistics.

Feb

Mar

Apr

May

Jun 2012

Jul

Aug

Sep

Oct

Everyday Price index, November 21, 2012

Prices Over The Long Term EPI vs. seasonally adjusted CPI (Jan 1987=100)

260 240

EPI →

220 200 180

↑ CPI

160 140 120 100

1987

1991

1995

1999

2003

2007

2011

The EPI is a proprietary index of AIER. The CPI is produced by the Bureau of Labor Statistics.

The second biggest EPI increase for October was in communication services prices, which grew 0.14 percent.

The prices of telephone services rose 0.22 percent, with prices of wireless services experiencing a second consecutive monthly increase of 0.3 percent. This is because companies tend to charge more for their wireless services as technological innovations offer consumers additional or improved functions. Prices for Internet services, by contrast, have shrunk steadily for the past five months.

They dropped 0.23 percent in October.

While the EPI fell in October, the CPI showed an increase of 0.15 percent. The biggest contributor to the CPI’s increase was housing. This category carries no weight in the EPI, since rents and mortgage payments may change in the aggregate but typically do not fluctuate from month to month for individuals.

The CPI’s shelter index climbed 0.3 percent last month.

Not only was this the largest price increase in housing prices since March 2008, it also accounted for more than half of the CPI’s increase. This means that future renters

may feel the pinch of price hikes as landlords charge them more. However, most homeowners’ mortgages won’t increase, and those who rent out their houses can expect higher incomes. While this is good news for homeowners, it is just a short-term benefit of inflation’s impact on housing prices. Once inflation spreads to other categories, overall prices will catch up with housing prices.

Although the EPI’s monthly changes are not usually dramatic, they add up over the long term. The October EPI shows that prices of frequently purchased items have risen 3.5 percent over the past 12 months. That’s almost 60 percent higher than the seasonally adjusted Consumer Price Index (CPI), which shows a 2.2 percent price increase over the same period.

This is in keeping with the EPI’s historical relationship with the CPI, as the chart at left shows. The EPI has a more volatile course than the CPI’s steady climb. But the EPI has also trended higher since 2002. Three factors can help explain why. First, since the EPI’s smaller basket includes such goods as oil, food, and prescription drugs— three categories that have experienced very high price growth since 2002—those categories get more weight.

Second, the EPI does not include contractually fixed items and durable goods, which tend to have more stable prices.

The final reason the EPI trends higher than the CPI is that the CPI uses quality adjustments to calculate prices.

For example, cell phones cost more now than they did 10 years ago, but they also often include Internet services, cameras, and GPS systems. The CPI adjusts the price of the phone down because consumers are getting more bang for their buck. This is a sensible way to get a full picture of the economy’s overall trends, but it does not capture the everyday experiences of consumers. Since the EPI does not include durable goods, it contains a much smaller percentage of items that are quality adjusted.

These differences shape the gap between the CPI and the EPI—which in turn suggests that Americans are experiencing a higher rate of erosion in buying power for day-to-day items than the CPI implies.

How we measure day-to-day inflation

A

IER’s Everyday Price Index (EPI) measures the changing prices of frequently purchased items like food and utilities. We do this by selecting the prices of goods and services from the thousands collected monthly by the Bureau of Labor Statistics in computing the Consumer Price Index. We choose

prices of goods and services that are typically purchased at least once a month and are not contractually bound over the longer term. Our staff economists then weight each category in proportion to its share of Americans’ average monthly expenditures.

T o learn more about our methodology, view the weights assigned to each component, and browse past EPI updates, visit AIER’s EPI Methodology page at www.aier.org/epi-methodology.

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org . r e i a

Everyday Price Index is published by American Institute for Economic Research, a nonprofit, scientific, educational, and charitable or­ganization. To contact AIER by mail, write to American Institute for Economic Research, PO Box 1000, Great Barrington, MA 01230. Find us on Facebook at facebook.com/AmericanInstituteForEconomicResearch, and on Twitter at twitter.com/aier. For more information or to donate, visit aier.org.

Business-Cycle Conditions, November 2012 AMERICAN INSTITUTE for ECONOMIC RESEARCH • www.aier.org • November 1, 2012

The Consumer Sees Reasons to Spend As the holiday season draws near, confidence rises because of falling unemployment, an improving housing market, lower debt, and buoyant stock prices.

by Steven R. Cunningham, PhD, Director of Research and Education

A

s goes the consumer, so goes the economy—at least in the U.S. Consumer spending has accounted for more than 70 percent of GDP since early in this recovery. As a result, any outlook must pay close attention to this massive force.

Right now, the consumer is out spending. This is particularly important in late October and early November as we go into the annual holiday buying season.

Consumers are feeling more confident for good reason. They have higher income and lower debt payments. They are less in debt, and their home values are appreciating rapidly. This should add up to a stable, if not growing, pattern of expenditure.

Even the employment numbers are bolstering consumer confidence. According to the October Bureau of Labor Statistics (BLS) report, the overall unemployment rate fell to 7.8 percent. While the size of the decline may be something of a statistical fluke—a number of factors came together unexpectedly—the direction is clear.

Moreover, at 18.5 weeks, the median duration of unemployment is the lowest it has been in three years.

Although unemployment and the duration of unemployment are falling, some argue that under-employment may be skewing the data. But pointing to underemployment as a sign of poor business conditions may be misleading. It is hard to hear, but in many cases workers are unlikely to find the same kind of employment they had in the past even as business conditions improve. Their training is a mismatch for the emerging new economy. That is, a lot of the under-employment is structural, not cyclical.

It is also easy to forget that the labor market is marked by broad variations across states and regions, and many areas are enjoying better-than-average job markets. The jobless rate in North Dakota is only 3 percent. Unemployment rates in 12 other states are under 6 percent, well below the national average that has hovered around the 8 percent mark for months. There is also a lot of variation according to worker age and degree attainment. While unemployment is highest among young and lower-skilled workers, the national

average rate for those over 25 years of age is 6.6 percent. For those over 25 who have a college degree, the rate is 4.1 percent.

The improvements in the labor market have created growing optimism among those who do not have jobs The Indicators at a Glance Percentage of AIER Leaders Expanding 100

73

75 50 25 0 1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

Percentage of AIER Coinciders Expanding 100

100

75 50 25 0 1985

1988

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Percentage of AIER Laggers Expanding 100

100

75 50 25 0 1985

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1991

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2000

Shaded bars represent official recessions.

2003

2006

2009

2012

Business-Cycle Conditions, November 1, 2012

and a sense of greater security among those who do. It is not a surprise that the Conference Board’s Consumer Confidence Index recovered to over 70 percent in the latest month for which data is available.

Incomes, while rising, constitute a comparatively weak spot in the improving economy because of the slow growth in wages. There is too much slack remaining in most areas of the labor market. Enough people

are still looking for jobs that employers don’t face much pressure to raise wages. After-tax incomes rose only 0.1 percent in the latest month, an increase more than offset by inflation.

On the positive side, after adjusting for inflation, incomes were still 1.8 percent above a year ago. At the same time, households are holding less debt and facing much lower payments on the amounts they owe.

Primary Leading Indicators 2000

Ratio of Manufacturing and Trade Sales to Inventories (3)

M1 Money Supply (1) (constant dollars, billions)

1.0 0.9

1000

0.8 0.7

500 800

0.6

Yield Curve Index (1) (cumulative total)

Vendor Performance: Slower Deliveries Diffusion Index (2) (%)

80

600

60

400

40

200

20

0 100

100

0

Index of Manufacturers' Supply Prices (2) (percent)

Index of Common Stock Prices (2) (constant purchasing power)

880

75

440

50

220

25

110

0 160

55

New Orders for Consumer Goods (3) (constant dollars, billions)

Average Workweek in Manufacturing (3) (hours)

46 44

80

42

40

40 38

20 80

New Orders for Core Capital Goods (4) (constant dollars, billions)

Initial Claims for Unemployment Insurance (3) (1000s, inverted)

160 260

40

360 460

20

560 660

10 2800

New Housing Permits (3) (thousands)

3-Month Percent Change in Consumer Debt (4)

12 10 8 6 4 2 0 -2 -4

1400 700 350 1950

2

1960

1970

1980

1990

2000

2010

1950

1960

1970

1980

1990

2000

2010

Business-Cycle Conditions, November 1, 2012

Household debt service payments have fallen to 10.7 percent of disposable income, the lowest level since 1993. This means consumers have increased buying power and are more willing to borrow to buy goods.

Fueled by this and by expanding consumer credit, real consumer spending rose by 2 percent over the same month last year, reaching an all-time high.

Rapid improvements in the housing and stock markets have further encouraged consumers by raising household wealth and buoying confidence. Housing starts continue to rise, and new-home sales were up 27.1 percent compared with the same month a year ago.

The prices of existing homes rose the most since 2005, with the median price rising 11.3 percent year-to-year.

Besides increasing household wealth, the rise in house prices suggests more labor mobility, allowing workers to move wherever jobs may be.

In addition, many homeowners have refinanced their mortgages at lower rates, while some have shortened the terms of their mortgages. Both make consumers feel richer and more likely to increase spending.

Securities markets continue to soar, bringing increased wealth to fuel consumer spending. The S&P 500 Index ended September more than 25 percent above August. The Dow Jones Industrial Average has more than doubled since its low point during the reces-

sion and is less than 5 percent off its all-time high.

Rising wealth and buying power translate into growing consumer demand. At 73 for the third consecutive month, AIER’s leading indicators reflect this growing strength with four of the indicators reaching new highs. Interpreting the remainder of the indicators requires a deeper look and an understanding of the role of each indicator in capturing information about the business cycle.

The negatives reflect the peculiar nature of this recovery, which follows from the peculiar nature of the recession that preceded it. This was a recession born of a real estate collapse that led to a financial crisis. The construction industry screeched to a halt. Policy initiatives designed to address these problems involved pouring money into financial institutions, which brought interest rates to abnormally low levels. All of this has an impact on business and capital formation.

We typically expect to see wholesale prices rise and deliveries slow as the expanding demand of a growing economy causes firms to approach production capacity.

Firms also expand inventories in anticipation of higher future sales. We normally take all of these as positives.

That’s not what’s happening this time. More than three years into the recovery, the capacity utilization rate remains under 80 percent. Companies are tak-

Primary Roughly Coincident Indicators 256

Nonagricultural Employment (1) (millions)

Manufacturing and Trade Sales (2) (constant dollars, billions)

1200

128

600

64

300 150

32 128

Index of Industrial Production (1) (2007 = 100)

Civilian Employment as a % of the Working-Age Population (2)

66

64

63

32

60

16

57

8

54

12800

Personal Income Less Transfer Payments (1) (constant $, billions)

Gross Domestic Product (1) (quarterly, constant dollars, billions)

20000 10000

6400

5000 3200

2500 1250

1600 1950

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2010

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2010

Notes: 1) Shaded areas indicate recessions as dated by the National Bureau of Economic Research. 2) The number in parentheses next to the name of a series is an estimate of the minimum number of months over which cyclical movements of a series are greater than irregular fluctuations. That number is the span of each series’ moving aver­age, or MCD (months for cyclical dominance), used to smooth out irregular fluctuations. The data plotted in the charts are those MCDs and not the base data.

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Business-Cycle Conditions, November 1, 2012

Primary Lagging Indicators 5

Average Duration of Unemployment (2) (weeks, inverted)

Ratio of Consumer Debt to Personal Income (1) (percent)

23

15

18

25

13

35

8

45

3

1600

Manufacturing and Trade Inventories (1) (constant dollars, billions)

% Chg. from a Year Earlier in Mfg. Labor Cost per Unit of Output (2)

16 12 8

800 400

4 0 -4

200

-8 -12

1600

Commercial and Industrial Loans (1) (constant dollars, billions)

Composite of Short-Term Interest Rates (1) (percent)

18 15

800

12

400

9

200

6

100

3

50

0 1950

1960

1970

1980

1990

2000

2010

ing advantage of low capital costs resulting from low interest rates, high cash holdings, and the collapse in the construction and real estate industries to build new facilities. But fearful of economic uncertainty, they have been slow to hire, expand machinery (new orders for core capital goods), and build up inventories. Extra capacity means fewer slowdowns in deliveries, fewer wholesale price increases, and less need for inventory buildups. Hence the negatives among the corresponding measures in our indicators.

As we said in our last Business-Cycle Conditions, businesses remain out of sync with growing consumer sector demand. They are responding in a rational way to real risks in the economy. This means their actions are measured. Firms will adjust as these risks are resolved.

When businesses get back in sync with the increasingly confident consumer, the remaining leading indicators should turn positive.

The remaining coincident and lagging indicators only confirm our view. Employment, industrial production, output, and sales measures all continue to improve.

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4

1950

1960

1970

1980

1990

2000

2010

Statistical Indicators of Business-Cycle Changes Change in Base Data Jun Jul Aug Sep Primary Leading Indicators.

Cyclical Status Aug Sep Oct

+ + -

+ + +

+ + +

+ M1 money supply + Yield curve index + Manufacturers’ supply prices

+ + -

+ + -?

+ + -?

-

+ +

+ -

New orders, consumer goods New orders, core capital goods + New housing permits

+ -? +

+ +

+ +

+ -

+ +

+ +

Ratio of sales to inventories + Vendor performance + Index of common stock prices

? +

? +

? +

nc -

+r + -

-

nc Average workweek, mfg.

- Initial claims, unemplmt. insurance* Change in consumer debt

+ + +

+ + +

+? + +

Percentage expanding cyclically + + +

+ + +

+ -

+ +

+ -

-

+ +r + nc

+ + + -

+ +

+

nc

73

73

73

Primary Roughly Coincident Indicators + Nonag. employment + + Index of industrial production + Pers. income less transfer payments +

+ + +

+ + +

Manufacturing and trade sales + Civilian emplmt. to population ratio Gross domestic product

+ ? +

+ ? +

-

-

+ +? +

Percentage expanding cyclically

100

100 100

Primary Lagging Indicators Avg. duration of unemployment* Manufacturing & trade inventories Commercial & industrial loans Ratio of cons. debt to income Chg. in labor cost/output, mfg.

Short-term interest rates

+? + + + +? ?

+? + + + +? ?

Percentage expanding cyclically

100

100 100

+? + + + +? ?

nc No change. r Revised. ­* Inverted. Under “Change in Base Data,” plus and minus signs indicate in­creases and decreases from the previous month or quarter and blank spaces indicate data not yet available. Under “Cyclical Status,” plus and minus signs indicate expansions or contractions of each series as cur­rently appraised; question marks indicate doubtful status when shown with an­other sign and indeterminate status when standing alone.

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