Month: July 2010

That's not a facetious or sarcastic question, I am puzzled.  Here is one story from yesterday:

Major corporations are expected to report some of their strongest profits in years.

“It has been one of the strongest profits recoveries ever,” said David S. Bianco, chief United States equity strategist for Bank of America Merrill Lynch. “You have got to go back to the Depression to find a profits recovery that outpaces this one.”

What are the options?

1. It's earnings manipulation and real economic profits aren't high at all.  Or they may represent capital consumption.

2. It's an oligopoly model and mark-ups are countercylical (NB: this would eaier to maintain if the recovery in output had been weaker).

3. Aggregate demand is recovering but a) workers are unemployed because, at current margins, their labor simply isn't worth very much, and b) real interest rates are low because of cushions of corporate cash.

4. We're seeing a lot of cost-lowering positive supply shocks, but AD remains stagnant.

Each of these explanations has its problems.  What other hypotheses should I be considering?

Addendum: Arnold Kling comments.

Henry Blodget has a quick primer on this topic, with some graphs and charts of interest.  My view is simple.  I see two major risks:

1. The currency-area-formerly-known-as-the-eurozone unwinds and Europe spirals into a major recession, taking down much of the world with it.

2. China implodes economically, taking down much of the world with it.

If neither of those two events happens, we should continue to see a recovery, with fits and starts, but a slow one in the labor market.

In other words, I'm still not an economic optimist, but I do have a rosier view of the default course than do many other commentators.  I just don't think the shocks have finished arriving.

Stuart Torr writes to me:

I've been reading many economics blogs since the start of the crisis (and well before) and I've listened to all the Econtalk podcasts on the crisis. Some of the skepticism comes from the projects not being "shovel ready" and taking too long to have a real stimulative impact. South Africa didn't have a banking crisis but we had a dramatic housing bubble (by far the most dramatic in the world in % terms from checking the back of "the Economist") and we did enter recession after the crisis hit. We also have massive investment in infrastructure because of the World Cup and those projects were only really getting going when the crisis hit. I'm sure there are technical reasons why this isn't relevant to the stimulus debate, but I've barely even seen it mentioned anywhere. Is it really that irrelevant?

Unemployment in South Africa had been 23.5 percent.  Yet, after the collapse and response, the unemployment rate is still rising and see also here for further information.  It's like trying to catch a falling knife, there is more information here. 

I don't know much about the South African economy, but I would think it is especially difficult to target many of the unemployed resources there.  There is weak infrastructure, many language groups, large distances, and a lack of political unity.

Here is one critique of what they are doing in South Africa with fiscal stimulus.  Here is a more positive treatment.

What do you all know about this case?

Kathleen Kahle, a professor at the University of Georgia's business school, offers another reason: the growth of high-tech companies, which tend to hold lots of cash. Younger, riskier firms have more difficulty raising money when credit is tight, so they keep more cash on hand, she says. "At the same time, they have a lot of growth opportunities and want to make sure that they have the funds necessary to invest in good projects," she adds.

At the end of the second quarter, the 54 biggest information-technology firms held $280 billion — or 27% of their assets — in cash, according to the Journal's analysis, a higher percentage than any other industry group. Cash balances grew further in the third quarter for the 34 companies in that group that have reported results.

Consider Google. The search giant's cash and short-term investments rose 53% to $22 billion in the third quarter from a year earlier, accounting for 58% of its total assets.

The cash provides "operating and strategic flexibility," Google Chief Executive Eric Schmidt told analysts last month. "We're very happy to have it sit in our bank account and earn a modest interest rate."

Here is more.  Apple is also hoarding cash.  This report suggests that hospitals are hoarding cash, as does this report.  Are these sectors weak in aggregate demand and expected aggregate demand?  No, quite the contrary.

We are told that this cash hoarding is a sign of weak AD, yet firms which face high demand for their products hold especially high levels of cash.  So is it a sign of both weak demand and strong demand?  Maybe so, but then we need to be very careful with inference and we must consider whether extant hypotheses explain the cross-sectional variation in cash holdings and not just the aggregate.  There are many puzzles in corporate finance, especially when it comes to explaining changes in the aggregates, and this is likely one of them.

These are only polls, but:

In a recent survey of company chief financial officers that Duke's Mr. Graham conducted with CFO Magazine, he found that companies expect capital spending to increase by 9% over the next year, compared with 1.5% when he asked the question in December. They expect employment to grow by 0.7%, compared with the 1.4% drop they expected six months ago.

When it comes to firms holding more cash, we still do not understand what is going on.  Here is my previous post on the topic.

Luckily, a new shop in China will let you vent your frustrations on other people's equipment without dealing so much as a scratch to your own. After paying for the right to abuse an old TV, mobile phone, plate, chair or other item — yes, the Pottery Barn rule still applies — you have up to one minute to unleash your wrath upon your target. As an additional bonus, the store makes motorcycle helmets and gloves available to prevent injuries. But there's a catch: if you're not a woman, you can't play. Looks like frustrated men will have to stick with the ol' pillow standby for now.

The link is here and I thank Vinnie and Trevor Wagener and also John Thorne for the pointer.  Here is further information.

I don't know and neither does anybody else.  Here is one set of recent estimates, as reported in The Guardian:

…economists at Dutch bank ING…have produced one of the first financial models of what might happen if the single currency falls apart during 2010. In a bleak assessment, entitled "quantifying the unthinkable", they warn that in the first year alone, so by the start of 2012, output would fall between 5% and 9% across various member states, while their new national currencies would fall by 50%.

Please don't fix those numbers in your mind, so here's the real point.  The new national currencies, of the poorer countries, would fall by some amount.  If that amount is small, that also provides reason to believe the current Eurozone can survive.  If that amount is large, it provides reason to believe the current Eurozone cannot survive.  (The poorer countries would now have to deflate a lot, and there would be a greater risk of a speculative attack on their banking systems.)

You might think that the collapse of the current Eurozone, and the devaluations, are good in the longer run (I do), but in the short run the entire process would be a nasty, volatility-laden, solvency-revaluing shock to the entire global economy.

You therefore should expect "either an OK outcome, or a very nasty shock," in exactly that conjunctive form.  You shouldn't expect something in between.  The conditions where the current Eurozone collapses are precisely the same conditions where the shock of transition is a big one.

And that includes a deflationary exchange rate shock to Germany as well.