Last week Scott Kirby, CEO of US Airways, announced at the Hudson Securities conference that 100% of their profits will stem from ancillary airline fees, such as checked baggage fees, seat or flight change fees, and on-board service.
Most of the commentary I have read on this concerns the usual storylines about consumer gripes on miscellaneous fees generally, there is another side that is being missed in the commentary.
(By the way if fees in generally annoy you, check your itemized cell phone bill.. many of those surcharges ... not to mention the purchase... are end-run ways for filling state coffers by politicians who just don't want to admit to voters they are raising your taxes).
But with regards to the airline, what I find interesting is that what the CEO is saying, is that after adding up all of the revenue from airline tickets, and subtracting from this number the real costs of running the airline: leasing the planes, paying salaries of pilots, attendants, ground crew, and agents, buying the fuel, and any bond interest or loan payments, the profitability of the entire operation is precisely zero. Zip. $0.
Now the literal capitalist would say the item that contributes marginal profit is the most important focal point of business management. As bag fees comprise the biggest component of all fee revenue, a literal capitalist reading is that all of the infrastructure and personnel exist to ensure bags get transported from one location to the next, since they provide all the profit. You are incidental to the bottom line since your fare just helps cover costs. Perhaps even more succinctly, your main job is to make sure those bags get to the counter so they can be checked in. When you pay for their transit you are throwing that money directly to the bottom line.
Now musing on the substantial costs invested in air transport infrastructure, from the oil drilled and refined into high-grade jet fuel, airport complexes, raw materials used to build and service planes, personnel hired etc. etc., this must represent the most capital intensive bag transport logistic operation, ever.
Richard Branson, the UK billionaire investor and entrepreneur had an interesting take. When he was asked how to become a millionaire, he quickly replied:
"There's really nothing to it. Start as a billionaire and then buy and airline."
He of course later invested in US Airways, before starting Virgin Atlantic Airways and most recently, Galactic.
Me, I'll stick with the carry-ons.
Tuesday, December 14, 2010
Tuesday, September 28, 2010
A Faith-Based Currency.... the Dollar is younger than Woodstock... the Red Queen always loses (a winning counter-move)... and the inflationary monkey on our back.
Through the Looking Glass.
The Red Queen is a mad character Alice encounters on the other side of the Looking Glass. She explains to Alice that she must run faster and faster just to stay in the same place:
Bubbles are rational reflections of efficient market hypothesis at work [sic]
Ask yourself: 'how many economists predicted the catastrophic effects of a housing collapse on our way of life?', or, even more succinctly, 'how many of them predicted that housing was even in a bubble, arguably the largest bubble in human history?'.
Certainly the heralded "maestro" Sir Alan Greenspan performed admirably as our very own Wizard of Oz:
Fuck in corporate America I'd get fired if my models failed for even a fraction of that time. You wouldn't last two hours at a Vegas craps table with that streak.
Alan though got knighted by the (English) Queen and Bob Woodward wrote a book on him. Does anyone see something wrong with this picture? Were we not groveling at the wrong graven image (Greenspan)... instead of relying upon our innate abilities to detect bullshit?
The US Dollar is not 200 years, nor even 100, years old. Try 39 years old.
After World War II the first world pegged their respective currencies to the US Dollar at fixed rates. The US Dollar in turn was fixed to gold, in a daisy-chain agreement known as the Bretton Woods Accord, so named after the New Hampshire town where it was signed. We were a gold dollar and the rest of the world linked to the dollar, so the world was effectively back on a gold standard.
Flash forward just 25 years. With US costs escalating from the Vietnam War, a desperate President Nixon eager for an inflationary economic boost to gain re-election, and a sceptical French government which started demanding repayment of US debt obligations in gold instead of paper dollars... all had a momentous consequence. In 1971 Nixon signed an executive order suspending the convertibility of the Dollar for gold. This in turn set loose all manner of free-floating currency foreign exchange chaos, catalyzed the foundations of the Euro, made Arab petrol prices fall below production costs (and resulting in the embargo to raise them above new costs), and launched the high inflation era of the 70's.
Before Nixon we were a gold dollar, as mandated by the US Constitution. After Nixon we were a fiat currency and subject to the government printing press (or ability to add zeros to the debt in server-land).
Put another way, all the Baby Boomers today are older than our modern free-floating fiat currency, and the Gen-X-Y-Millenials (etc) have known nothing but inflationary fiat dollars. This is how currencies revalue when artifice is used to elevate their values and then the props are kicked out from under them for political gain.
Why the government apparatus now depends upon fiat inflation.
Simple. Debt we issue today is worth less tomorrow with inflation. It reduces the obligations of money that must be repaid to those who buy our Treasury bonds. Today's debt becomes cheaper tomorrow. Great!
Tally the trillions of dollar inked for Medicare & Medicaid, plus the new health care bill, and we've got a big check that our tax base won't cover without cheapening the currency to make it all happen. I believe all of these programs are necessary, even moral, but that we also have to be honest with people about their costs and safeguarding them from fraud.
The only trick for issuing evermore debt, of course, is that you have to ensure that you'll always have a ready supply of buyers for your debt who don't realize they are being had. They have to continue to think they're getting a good deal relative to other choices. It must also be done at a controlled rate or its game over, man, game over.
The Red Queen is the Monkey on our Back.
Inflation will destroy your paper savings, it is a mathematical guaranty.
Imagine you have a new child when you hear inflation has been 'contained forever' at 3%. After one year a saved $100 is now worth $97 in comparable purchasing power. When li'l junior or miss is ready to go to college, that same $100 initially put into a checking account is now only worth ~$58, for a total real loss of 42%. And all that assumes you never had to pay any taxes or account fees on the deal (meanwhile college expenses have risen by large amounts year-over-year in the interim).
Say you get interest on that money? Great! Subtract your annual tax bracket from that rate of return and recompute. Just to stay even at a 28% bracket means you need to find a savings rate of around 4.2% just to stay even on an after-tax, after-inflationary basis in this scenario (assuming no account fees, of course).
We have a faith-based currency.
Does not the government print "In God We Trust" on the currency itself?
Remember Dollars today are just paper and e-bits on financial servers, backed only by the full faith and credit of our government. Is there anyone out there who would propose our government acts as responsible stewards of the Republic over their own re-election?
Avoid Red Queen myopia.
The way to advance personal wealth interests is to advantageously switch among asset classes at the height of their valuation cycle before the mathematical underpinnings fail.
The presumption that growth in any one class may double infinitely per unit of time underscores the blind madness of the Red Queen:
Diversification among sensible asset classes is a relatively good way for you to topple the Red Queen, because even in an inflationary environment staying par with respect to real purchasing power means you win.
The Red Queen is a mad character Alice encounters on the other side of the Looking Glass. She explains to Alice that she must run faster and faster just to stay in the same place:
.. said the Queen. `Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!'During bull markets many adopt Red Queen thinking. Rare is the pundit who highlights the risks of throwing more and more dollars at the same thing in the hope of achieving outsized returns. Indeed most window-dressing debate is meant to keep the party going, not temper its excess.
Bubbles are rational reflections of efficient market hypothesis at work [sic]
Ask yourself: 'how many economists predicted the catastrophic effects of a housing collapse on our way of life?', or, even more succinctly, 'how many of them predicted that housing was even in a bubble, arguably the largest bubble in human history?'.
Certainly the heralded "maestro" Sir Alan Greenspan performed admirably as our very own Wizard of Oz:
'American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home.' Alan Greenspan, Credit Union National Association 2004 Governmental Affairs Conference, Washington, D.C. February 23, 2004Then Alan lobs a real ball-buster, but coming from him the media fawns over each word as if from Moses himself:
“The fact that our economical models at The Fed, the best in the world, have been wrong for fourteen straight quarters, does not mean they will not be right in the fifteenth quarter."Ex-squeeze me? A baking powder? Putting aside for just a moment as to what qualifies as the "best in the world"... remember 14 quarters is like 3 and 1/2 YEARS of being wrong. That's a hella long trips around the sun and almost as long as it took for me to graduate college.
Fuck in corporate America I'd get fired if my models failed for even a fraction of that time. You wouldn't last two hours at a Vegas craps table with that streak.
Alan though got knighted by the (English) Queen and Bob Woodward wrote a book on him. Does anyone see something wrong with this picture? Were we not groveling at the wrong graven image (Greenspan)... instead of relying upon our innate abilities to detect bullshit?
The US Dollar is not 200 years, nor even 100, years old. Try 39 years old.
After World War II the first world pegged their respective currencies to the US Dollar at fixed rates. The US Dollar in turn was fixed to gold, in a daisy-chain agreement known as the Bretton Woods Accord, so named after the New Hampshire town where it was signed. We were a gold dollar and the rest of the world linked to the dollar, so the world was effectively back on a gold standard.
Flash forward just 25 years. With US costs escalating from the Vietnam War, a desperate President Nixon eager for an inflationary economic boost to gain re-election, and a sceptical French government which started demanding repayment of US debt obligations in gold instead of paper dollars... all had a momentous consequence. In 1971 Nixon signed an executive order suspending the convertibility of the Dollar for gold. This in turn set loose all manner of free-floating currency foreign exchange chaos, catalyzed the foundations of the Euro, made Arab petrol prices fall below production costs (and resulting in the embargo to raise them above new costs), and launched the high inflation era of the 70's.
Before Nixon we were a gold dollar, as mandated by the US Constitution. After Nixon we were a fiat currency and subject to the government printing press (or ability to add zeros to the debt in server-land).
Put another way, all the Baby Boomers today are older than our modern free-floating fiat currency, and the Gen-X-Y-Millenials (etc) have known nothing but inflationary fiat dollars. This is how currencies revalue when artifice is used to elevate their values and then the props are kicked out from under them for political gain.
Why the government apparatus now depends upon fiat inflation.
Simple. Debt we issue today is worth less tomorrow with inflation. It reduces the obligations of money that must be repaid to those who buy our Treasury bonds. Today's debt becomes cheaper tomorrow. Great!
Tally the trillions of dollar inked for Medicare & Medicaid, plus the new health care bill, and we've got a big check that our tax base won't cover without cheapening the currency to make it all happen. I believe all of these programs are necessary, even moral, but that we also have to be honest with people about their costs and safeguarding them from fraud.
The only trick for issuing evermore debt, of course, is that you have to ensure that you'll always have a ready supply of buyers for your debt who don't realize they are being had. They have to continue to think they're getting a good deal relative to other choices. It must also be done at a controlled rate or its game over, man, game over.
The Red Queen is the Monkey on our Back.
Inflation will destroy your paper savings, it is a mathematical guaranty.
Imagine you have a new child when you hear inflation has been 'contained forever' at 3%. After one year a saved $100 is now worth $97 in comparable purchasing power. When li'l junior or miss is ready to go to college, that same $100 initially put into a checking account is now only worth ~$58, for a total real loss of 42%. And all that assumes you never had to pay any taxes or account fees on the deal (meanwhile college expenses have risen by large amounts year-over-year in the interim).
Say you get interest on that money? Great! Subtract your annual tax bracket from that rate of return and recompute. Just to stay even at a 28% bracket means you need to find a savings rate of around 4.2% just to stay even on an after-tax, after-inflationary basis in this scenario (assuming no account fees, of course).
We have a faith-based currency.
Does not the government print "In God We Trust" on the currency itself?
Remember Dollars today are just paper and e-bits on financial servers, backed only by the full faith and credit of our government. Is there anyone out there who would propose our government acts as responsible stewards of the Republic over their own re-election?
Avoid Red Queen myopia.
The way to advance personal wealth interests is to advantageously switch among asset classes at the height of their valuation cycle before the mathematical underpinnings fail.
The presumption that growth in any one class may double infinitely per unit of time underscores the blind madness of the Red Queen:
- No investment may compound infinitely without natural corrective forces.
- Attempts to subvert the first precept invites catastrophic default, as these attempts invariably take on characteristics of bubble psychology.
Diversification among sensible asset classes is a relatively good way for you to topple the Red Queen, because even in an inflationary environment staying par with respect to real purchasing power means you win.
Monday, September 20, 2010
Model forecast confirmed!
Well today the National Bureau of Economic Research (NBER) declared the ending date of the Great Recession. They put the end of the current downturn as June of 2009. In my charter blog post from March 6th 2010 I placed the end of the downturn as July of 2009, confirming that my approach was sound.
I think this helps prove my point with respect to how economic data mining can be effectively used: (1) intuitive but simple approaches that work, or (2) excessively complex models or methods that take months or years to "prove" correct.
My point with the initial post was to illustrate the practical benefits of the former over the latter. When one can adequately predict the key points with as few inputs as possible, then it should be deployed as a first-response diagnostic. The benefits are that policy makers, business leaders, and voters(!) can therefore more quickly react to a new economic reality and mitigate the tendency of a cycle to swing in excessive directions.
Of course in-depth research should be done to better understand how we collectively create messes that are costly and time-consuming to clean up, but these lags in time should not be used (as they are today) as an excuse to befuddle the masses with time-wasting debates.
As it stands today we have quite enough economic illiterates and short-term thinkers sitting in positions of power across government, the media and business sectors, who make decisions that affect a great many people, so the less time we data mining analysts give them to speculate on whether the earth is round the better off we will all be, on average, over the long term.
I think this helps prove my point with respect to how economic data mining can be effectively used: (1) intuitive but simple approaches that work, or (2) excessively complex models or methods that take months or years to "prove" correct.
My point with the initial post was to illustrate the practical benefits of the former over the latter. When one can adequately predict the key points with as few inputs as possible, then it should be deployed as a first-response diagnostic. The benefits are that policy makers, business leaders, and voters(!) can therefore more quickly react to a new economic reality and mitigate the tendency of a cycle to swing in excessive directions.
Of course in-depth research should be done to better understand how we collectively create messes that are costly and time-consuming to clean up, but these lags in time should not be used (as they are today) as an excuse to befuddle the masses with time-wasting debates.
As it stands today we have quite enough economic illiterates and short-term thinkers sitting in positions of power across government, the media and business sectors, who make decisions that affect a great many people, so the less time we data mining analysts give them to speculate on whether the earth is round the better off we will all be, on average, over the long term.
Saturday, March 13, 2010
Where would you hide a trillion dollars?
A trillion dollars is a lot of money. It is in fact more than actually exists in circulation. And it is presently hiding from everyone in plain sight at the Federal Reserve.
Regular Reserves of Depository Institutions have historically been the pots of money that banks have to show the Fed, to assure them they are still capable of staying open. Think of a casino where you can't get in, until the guy sees that you have a few 20 spots in your pocket. Little noticed, the Reserves numbers just sort of stayed there year in and year out and are very boring.
Excess Reserves are the money that banks put into the Fed when things get a little jumpy out there, above and beyond Regular. Big moves in Excess Reserves are basically when the Fed turns into a panic room, and banks stuff it with their money. When the all-clear is sounded they take it back again and go about their business. Excess Reserves are Run-to-Daddy time.
For decades Excess Reserves have been rather steady, with the bumps generally coinciding with notable geo-political events or financial crises (click to enlarge):
Then of course in 2007 the real estate bubble began its overdue correction and all hell broke loose as it imploded. Let's look at 2001-July 2009, to put the 9/11 'spike' into relative context with the advent of the financial crisis:
So what happened? Well part of the bailout, er, stabilization, was the Federal Reserve announcing in October 2008 that they would start paying interest to banks on their excess reserves. The concordant amount of money-equivalents that fled the system to the Fed safehouse jumped $200BN in that month, and by New Years stood at $767 billion.
That's a huge shift. The amount of money that went into this category in just three months, exceeded the total amount of money we've spent on the war in Iraq since its beginning ($711 billion as of the time of this writing).
Banks are now being paid by the Federal Reserve to park cash or junk assets counted the same-as-cash, whereas before they were not paid and would therefore lose money (since banks make money by lending it out).
Now perhaps the official story is true, and the fact that lending dropped off a cliff to credit-worthy businesses and others at the same time banks were getting paid was a sheer coincidence. What does not appear to be in dispute is that the reduction in lending exacerbated the recession, likely further hurting employment and sending real estate another leg down. Since reserves are needed by banks to actively make loans, I find the official story a little hard to believe.
But let's expand the view through present, to get a sense for how big this program has gotten since the stabilization rationale was presented.
As of February 2010 there was $1.162 trillion dollars in Excess Reserves at the Federal Reserve, and its not slowing.
Interestingly the interest being paid to banks on these balances comes to just about $3 billion dollars annualized. If the Fed was buying 5-year Treasuries at around 2.25% then the Fed is making the difference of about 2%, or $23 billion in profit.
What I think is most concerning though is that I believe the Fed is setting the stage for market distortion in the years to come in a way that could impact everyone from wage workers to retirees. The Fed is taking these Excess Reserves and using them to buy other assets like US Treasuries. This can create the appearance of strong market support for the US dollar, since the mass purchases by the Fed of US Treasuries is helping keep those prices higher (and interest rates lower) than would be the case if free markets were to set the price.
Not unlike some of the recent Ticketmaster scandals... by those hackers who cracked the code and bought all the tickets for hot concerts before they went on sale to the public, who were then in turn forced to pay higher prices from re-sellers... if all this use of Excess Reserves is adding artifice to the US Dollar without fixing the underlying problems in US banking institutions (such as unregulated derivatives), then it could be the underpinnings of an even larger house of cards that market forces will eventually correct. If the markets correct the imbalance in a sharp, uncontrollable way interest rates could skyrocket.
We also call this monetizing the debt, and it often leads to hyperinflation with rapidly rising prices (without necessarily any increase in pay for the people).
So, monetization of sovereign debt is one of those really, really big no-no's. It can lead to rather Weimer-esque replays that we should be re-studying now, because the use or abuse of Excess Reserves as a monetary tool could be affecting the Treasury prices in a way that looks pretty now, but is in fact masking structural defects in the trading schemes of Wall Street.
We ought not be afraid of creative destruction, capitalism needs a clear view to separate the winners from the losers. We've spent a lot of time trying to prop up the losers in this business cycle. I would have rather we conserved those resources for more important initiatives, such as renewable energy, investments in mass transportation, or public education. It will telling to watch the ER figure to see what the Financial system and the Fed are doing with US capital flows, and to see how any distortions in the treasury market affects our ability to grow sustainably.
Peace out.
Regular Reserves of Depository Institutions have historically been the pots of money that banks have to show the Fed, to assure them they are still capable of staying open. Think of a casino where you can't get in, until the guy sees that you have a few 20 spots in your pocket. Little noticed, the Reserves numbers just sort of stayed there year in and year out and are very boring.
Excess Reserves are the money that banks put into the Fed when things get a little jumpy out there, above and beyond Regular. Big moves in Excess Reserves are basically when the Fed turns into a panic room, and banks stuff it with their money. When the all-clear is sounded they take it back again and go about their business. Excess Reserves are Run-to-Daddy time.
For decades Excess Reserves have been rather steady, with the bumps generally coinciding with notable geo-political events or financial crises (click to enlarge):
Then of course in 2007 the real estate bubble began its overdue correction and all hell broke loose as it imploded. Let's look at 2001-July 2009, to put the 9/11 'spike' into relative context with the advent of the financial crisis:
So what happened? Well part of the bailout, er, stabilization, was the Federal Reserve announcing in October 2008 that they would start paying interest to banks on their excess reserves. The concordant amount of money-equivalents that fled the system to the Fed safehouse jumped $200BN in that month, and by New Years stood at $767 billion.
That's a huge shift. The amount of money that went into this category in just three months, exceeded the total amount of money we've spent on the war in Iraq since its beginning ($711 billion as of the time of this writing).
Banks are now being paid by the Federal Reserve to park cash or junk assets counted the same-as-cash, whereas before they were not paid and would therefore lose money (since banks make money by lending it out).
- "The payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability while implementing the monetary policy that is appropriate in light of the System's macroeconomic objectives of maximum employment and price stability." - FRB Press Release, October 6, 2008.
Now perhaps the official story is true, and the fact that lending dropped off a cliff to credit-worthy businesses and others at the same time banks were getting paid was a sheer coincidence. What does not appear to be in dispute is that the reduction in lending exacerbated the recession, likely further hurting employment and sending real estate another leg down. Since reserves are needed by banks to actively make loans, I find the official story a little hard to believe.
But let's expand the view through present, to get a sense for how big this program has gotten since the stabilization rationale was presented.
As of February 2010 there was $1.162 trillion dollars in Excess Reserves at the Federal Reserve, and its not slowing.
Interestingly the interest being paid to banks on these balances comes to just about $3 billion dollars annualized. If the Fed was buying 5-year Treasuries at around 2.25% then the Fed is making the difference of about 2%, or $23 billion in profit.
What I think is most concerning though is that I believe the Fed is setting the stage for market distortion in the years to come in a way that could impact everyone from wage workers to retirees. The Fed is taking these Excess Reserves and using them to buy other assets like US Treasuries. This can create the appearance of strong market support for the US dollar, since the mass purchases by the Fed of US Treasuries is helping keep those prices higher (and interest rates lower) than would be the case if free markets were to set the price.
Not unlike some of the recent Ticketmaster scandals... by those hackers who cracked the code and bought all the tickets for hot concerts before they went on sale to the public, who were then in turn forced to pay higher prices from re-sellers... if all this use of Excess Reserves is adding artifice to the US Dollar without fixing the underlying problems in US banking institutions (such as unregulated derivatives), then it could be the underpinnings of an even larger house of cards that market forces will eventually correct. If the markets correct the imbalance in a sharp, uncontrollable way interest rates could skyrocket.
We also call this monetizing the debt, and it often leads to hyperinflation with rapidly rising prices (without necessarily any increase in pay for the people).
So, monetization of sovereign debt is one of those really, really big no-no's. It can lead to rather Weimer-esque replays that we should be re-studying now, because the use or abuse of Excess Reserves as a monetary tool could be affecting the Treasury prices in a way that looks pretty now, but is in fact masking structural defects in the trading schemes of Wall Street.
We ought not be afraid of creative destruction, capitalism needs a clear view to separate the winners from the losers. We've spent a lot of time trying to prop up the losers in this business cycle. I would have rather we conserved those resources for more important initiatives, such as renewable energy, investments in mass transportation, or public education. It will telling to watch the ER figure to see what the Financial system and the Fed are doing with US capital flows, and to see how any distortions in the treasury market affects our ability to grow sustainably.
Peace out.
Saturday, March 6, 2010
The Great Recession ended in July 2009 (give or take)
One might reasonably think the process for mapping the beginning and ending of recessions is a fairly transparent and straightforward process. After all, the economic cycle is integral to the lives of most everyone I know (and to the remainder, I envy you) but the truth is that these calls come months, if not a year or more after the fact.
Just who makes these calls anyway? Well despite our massive investments in the public sector and related data collection activities, there is in fact no one in the DC apparatus... no presidential appointee, no congressional committee, nay, not even an intern, charged with this rather important task.
Most tune in to the reports issued by an entity called the National Bureau of Economic Research (NBER). The NBER is a private, non-profit group that does quantitative and fundamental analyses on the economy out of the brain trust cities of Cambridge, Palo Alto and New York. And it really is the only one that declares when recessions begin and end. Typically these declarations come months (if not a year or more) after the fact. For our current Great Recession, they didn't identify the start date of December 2007 until November 27 2008!
This sort of strikes me like an ump who waffles on calling the pitch, when it's kinda sorta needed right there. According to the Rulebook of the Economy however, the umps at the NBER have the option of heading home, and watching the replay from five different angles before making the call. Meanwhile the rest of us hold our collective breath, hope our jobs don't go poof, and all the while policy makers waste time arguing whether or not there is a recession and what should (or should not) be done about it.
So what goes on inside the NBER? Well as a card-carrying member of the Public I don't know either. Now in reality I like the organization and I poke fun at them in jest, but seriously, in the age of Now the wait just seems damn slow. I can't understand why it takes so long to "declare" a beginning of a recession or its end.
I have a superabundance of enthusiasm, a trait inversely proportional to patience. In layman's terms this means that for me, spending three long years to see the entire Lord of the Rings trilogy practically drove me batshit. Lesson learnt, I chose to wait and watch seasons 1-4 of "Lost" all in one Epic DVD blast. I was much happier.
Now as a Quant, when I see gigabytes of data (in many cases floating free on those internets) I want to wrestle with it, pound it, spank it, and above all make it give me answers. The statistical methods are a means to enlightenment, a way for me to cut through the bullspin and identify where we are now and what conditions will likely prevail tomorrow.
And when I see a pattern emerge from columns of dummy variables I screech, buckle down and compute.
I spent some time poring over different public data sets in order to find a better real-time indicator of the economic cycle. In the matter of recessionary starts and stops I discovered one that appears to be uniquely suited to the task, and I have been following it monthly since the first term of the second Bush.
I found the keystone within the Bureau of Labor Statistics, which among other series discloses US Non Farm Payroll data. Most media report the same data, which is monthly or weekly estimated changes but there is one iteration of the raw data which is routinely overlooked and must be computed manually.
1. Take the raw data series (curiously, better delivery of BLS from the St. Louis Fed Reserve) and import to Excel.
2. Text-to-column the series
3. Compute simple Year-over-Year percentages, subtracting integer '1' from the result.
4. Overlay NBER Cycle Dates.
5. Multi-line plot to get the following (click to enlarge).
This series covers monthly data for 70 years, from 1940 - Feb 2010.
The blue line shows the YOY change in Non Farm Payroll data (seasonally-adjusted, though NSA is comparable).
The vertical red lines are the NBER-declared beginning and end dates for officially-declared recessions in the United States. The 0% YOY horizontal line is set about the middle of the chart, to better clarify the positive and negative deltas in relation to the recessionary periods.
Note that nearly every declared end to a recession (no matter when it was declared, often much later) occurs around an absolute trough bottom in the YOY series. This doesn't mean the pain is over, but rather that the rate of job losses is slowing down instead of accelerating. The economy grinds its way back towards the growth line (0% is the inflection) even though Main St is still shrinking, until it reaches positive growth again.
The precise beginnings of recessions are a little more nebulous using this method/series but generally coincide with:
Let's zoom in closer to the Naughty decade ('00+):
Just who makes these calls anyway? Well despite our massive investments in the public sector and related data collection activities, there is in fact no one in the DC apparatus... no presidential appointee, no congressional committee, nay, not even an intern, charged with this rather important task.
Most tune in to the reports issued by an entity called the National Bureau of Economic Research (NBER). The NBER is a private, non-profit group that does quantitative and fundamental analyses on the economy out of the brain trust cities of Cambridge, Palo Alto and New York. And it really is the only one that declares when recessions begin and end. Typically these declarations come months (if not a year or more) after the fact. For our current Great Recession, they didn't identify the start date of December 2007 until November 27 2008!
This sort of strikes me like an ump who waffles on calling the pitch, when it's kinda sorta needed right there. According to the Rulebook of the Economy however, the umps at the NBER have the option of heading home, and watching the replay from five different angles before making the call. Meanwhile the rest of us hold our collective breath, hope our jobs don't go poof, and all the while policy makers waste time arguing whether or not there is a recession and what should (or should not) be done about it.
So what goes on inside the NBER? Well as a card-carrying member of the Public I don't know either. Now in reality I like the organization and I poke fun at them in jest, but seriously, in the age of Now the wait just seems damn slow. I can't understand why it takes so long to "declare" a beginning of a recession or its end.
I have a superabundance of enthusiasm, a trait inversely proportional to patience. In layman's terms this means that for me, spending three long years to see the entire Lord of the Rings trilogy practically drove me batshit. Lesson learnt, I chose to wait and watch seasons 1-4 of "Lost" all in one Epic DVD blast. I was much happier.
Now as a Quant, when I see gigabytes of data (in many cases floating free on those internets) I want to wrestle with it, pound it, spank it, and above all make it give me answers. The statistical methods are a means to enlightenment, a way for me to cut through the bullspin and identify where we are now and what conditions will likely prevail tomorrow.
And when I see a pattern emerge from columns of dummy variables I screech, buckle down and compute.
I spent some time poring over different public data sets in order to find a better real-time indicator of the economic cycle. In the matter of recessionary starts and stops I discovered one that appears to be uniquely suited to the task, and I have been following it monthly since the first term of the second Bush.
I found the keystone within the Bureau of Labor Statistics, which among other series discloses US Non Farm Payroll data. Most media report the same data, which is monthly or weekly estimated changes but there is one iteration of the raw data which is routinely overlooked and must be computed manually.
1. Take the raw data series (curiously, better delivery of BLS from the St. Louis Fed Reserve) and import to Excel.
2. Text-to-column the series
3. Compute simple Year-over-Year percentages, subtracting integer '1' from the result.
4. Overlay NBER Cycle Dates.
5. Multi-line plot to get the following (click to enlarge).
This series covers monthly data for 70 years, from 1940 - Feb 2010.
The blue line shows the YOY change in Non Farm Payroll data (seasonally-adjusted, though NSA is comparable).
The vertical red lines are the NBER-declared beginning and end dates for officially-declared recessions in the United States. The 0% YOY horizontal line is set about the middle of the chart, to better clarify the positive and negative deltas in relation to the recessionary periods.
Note that nearly every declared end to a recession (no matter when it was declared, often much later) occurs around an absolute trough bottom in the YOY series. This doesn't mean the pain is over, but rather that the rate of job losses is slowing down instead of accelerating. The economy grinds its way back towards the growth line (0% is the inflection) even though Main St is still shrinking, until it reaches positive growth again.
The precise beginnings of recessions are a little more nebulous using this method/series but generally coincide with:
- A steep declination in positive job YoY that reaches the ~0.75-1.30% zone, and
- Continues to fall through the 0% floor into negative territory.
Let's zoom in closer to the Naughty decade ('00+):
The telecom-dot com recession occupies a relatively short period at the beginning of the decade. Our current recession is pegged as starting in December 2007 and no end has yet been declared. However notice the trough was reached around July 2009 and job losses have been slowing on a YOY basis ever since. If whatever methodology used by the NBER holds true for this cycle, then I believe this supports the notion that eventually they will declare the end of the current recession as being somewhere in the summer of 2009.
The reason I think this pattern holds through many different cycles (and they all had varying causes) is that non farm payroll data in absolute form is the best indicator of growth and contraction, period. These data estimate how many people are actively collecting paychecks, and represent creative destruction cycles as one industry (or cheap money cycle, asset class, etc) rises, plateaus, fades and is replaced by other growing segments of the economy.
This to me is an elegant series.
The purpose of this indicator is not to displace careful study that is needed on the business cycle. Rather the idea is to provide early warning indicators to policy makers, bankers, business leaders and academia so that we can take actions to keep the economy growing in a sustainable way, and be aware well in advance of a severe decline so we can mitigate the impacts on ordinary Americans. If the exact dates end up being revised a bit back and forth later, so be it! Just as doctors help us monitor our health in a preventive sense, we can do better to monitor our overall economy and communicate these findings to the public in a sensible way.
While many in our country were bearing the early brunt of the recession in 2008-2009, there were too many at the controls who were in denial that a contraction was underway. Bond measures, social programs and war spending all amped up as if we were just taking a breather. As we have seen, those assumptions proved baseless and ended up doing more harm in the long run.
Forewarned, forearmed.
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