The Oser View

New Homes et al

Sales of new homes collapsed even further in March to a seasonally-adjusted annual rate of 526,000, according to Census Bureau figures.  Sales fell in all regions of the country, and the median home price plummeted to $227,600 from $262,600 just a year ago.  The percentage declines in sales and median price were the most in decades.  At the present pace and despite a slowing of new building permits and housing starts, it will take 11 months to clear the inventory of available homes.  It takes 4-5 months in more normal times.  New homes can be sold at any stage from pre-construction to finished product.  From the homebuilder’s point of view, it’s obviously better to sell as early in the process as possible, but this trend too has been going in the wrong direction.  In 2006, 32% of 1,051,000 new homes sales were made after the homes were completed.  In 2007, of 776,000 new homes sold, 42% remained unsold until completion.  So far this year, 49% of new home sales have been of finished homes.

The Commerce Department reported that sales of durable goods—products designed to last three years or more—increased 1.5% in March, excluding transportation.  Sales of machinery and fabricated metals were particularly strong as foreign buyers took advantage of the weakening value of the dollar versus other currencies.  Inventories are beginning to pile up, however, which could signify slower production ahead as US consumers cut back on spending.

Greg Ip reported in the Wall Street Journal that the Fed is likely to cut the fed funds target rate by one-quarter of a percent to 2.00% next week, but then hold it steady.  Ip was Alan Greenspan’s favorite source for leaking information he did not wish to announce publicly.  Perhaps Ben Bernanke is taking a page from Greenspan’s playbook.

Producer Prices

The Labor Department reported today that the Producer Price Index, a broad gauge of wholesale prices rose 1.1% from February and is now up 6.9% year-over-year.  Commodity prices are soaring, for energy of course, but also for food.  Farm product costs in total have increased 19% in the last year.  Grains are up 65%, eggs 68%, fats and oils 54%, and oilseeds (grains that can be used both for food and oil) 92%. 

In a speech yesterday in Beijing, Gerald Bange, Chairman of the World Agriculture Outlook Board for the USDA, noted that corn prices have risen to record levels because “corn use for ethanol in the US is projected to rise more than 50% in 2008.”  He added that in though corn production is increasing world wide, “it is virtually certain that the demand for corn to produce ethanol in the US will keep US and world commodity prices at historically high levels.”

The New York Times reported this morning that several finance ministers and central bankers from major industrialized countries “demanded a reconsideration of biofuel policies adopted recently in the West.”  These policies include the Energy Independence and Security Act of 2007, which mandates that US gasoline consumption include nine billion gallons of renewable fuel this year rising to 15 billion gallons by 2015.  In 2008, this standard will be exceeded by corn ethanol alone. 

Rice

One-fifth of the calories consumed by human beings come from rice. Rice is the staple diet for half the world’s population. The price of rice futures on the Chicago Board of Trade has increased 86% since last summer.

The US Department of Agriculture’s latest estimate for global milled rice production in 2008 is a record 425.3 million tons. But, projected year-end stockpiles of 77.2 million tons will be just half what they were in 2001. Rice is unusual in that only about 6.5% of the total global harvest is exported. The rest is consumed in the countries where it’s grown. For example, China, which grows 30% of the world’s rice, consumes 98% of its production. Indonesia, the third largest producer, is a net importer. The United States accounts for a mere 1.5% of global production, yet we are a major rice exporter because we consume less than two-thirds of what we grow.

Thailand is the world’s number one rice exporter by far. Though it grows less than 5% of the world’s rice, it represents a third of the export market. Export prices for Thailand’s top-grade milled white rice have risen 58% just since March and have more than doubled since late January. The year-over-year price increase is 163%. Vietnam is another major exporter, but its authoritarian government recently "asked" rice exporters to stop signing new contracts, at least until June. The government is also considering a special tax on exports. As a result, Vietnam’s exports are expected to decline 11% in 2008, and prices could rise 30% more, from $700 to $900 a ton. China, India, and Indonesia have also imposed export restrictions, and Pakistan will ship 15% less rice because of power shortages at rice mills.

The Phillipines are at the other end of the spectrum. Already the world’s largest rice importer, the country is expected to increase this year’s imports 42% to curb speculation. Phillipines President Gloria Arroyo recently warned against hoarding and threatened jail to anyone "stealing rice from the people." US ambassador Kristie Kenney promised to supply all the rice needed, not so much for humanitarian reasons, but because the Phillipines is "a front-line state in the war on terrorism."

The rapidly rising cost of rice is not an isolated incident. The United Nations Food and Agriculture Organization reported a 57% year-over-year increase in global food prices.

Commodity prices in general have been on the rise for seven years, for a variety of disparate reasons. One, perversely, is that the developing world is becoming more affluent. Ernst Engel, a 19

th

Century Prussian statistician, was the first to demonstrate that poorer households spend a greater percentage of their income on food than wealthier households. At the lowest economic strata, 80% or more of a family’s income may go for food, and poorer families subsist on the cheapest source of calories. As income increases, more meat and less starches are consumed.

Animals thus become competitors for grain with people, and since meat and dairy products are more profitable for growers, guess who wins. In the 21

st

Century, machines are becoming competitors too. Corn, wheat, soybeans, palm oil and maize are in demand as the raw material for bio-fuels. According to the World Bank, almost the entire increase in world-wide maize production between 2004 and 2007 went for bio-fuels. Rising energy prices also contribute to rising food costs by making transportation more expensive.

Another reason for rising commodity prices is speculation. Citigroup reported that investments by speculators in commodities have increased by $70 billion or 21% so far this year. Climate change is having an impact, too. Australia has been in a nearly continuous drought for seven years and during that time, its rice production has been virtually nil. In the US, heavy rains and flooding in the Mississippi delta will curtail production. More acerage in West and Sub-Saharan Africa is coming under production, but, with desertification increasing, it tends to be of poorer quality, resulting in lower yields.

Because of rising energy and food costs, inflation is building throughout the developing world. The International Monetary Fund has estimated that consumer prices in emerging economies will rise 7.4% this year, the most since 2001. In many countries, inflation will be much higher. Some places are surprising. In Latvia the inflation rate was 16.8% in March and food costs rose 21%. Next door in Lithuania, inflation rose 11.3% with food up 18.1%. The numbers for Egypt are 12.1% and 16.8%. Even in China, inflation is at an 11-year high.

Many governments are responding to rising inflation by imposing price controls. In Mexico, for instance, the government capped the price of corn tortillas at 8.5 pesos a kilogram last year. The cap is now expiring and the price of tortillas is predicted to rise to 15 pesos. The Russian government is imposing controls on bread, eggs, and milk. The World Bank reports that 21 countries, from Argentina to Yemen, now have price controls on staple foods. Price controls, however, are not free. In a globalized economy they create distortions that can easily produce more harm than good, plus they often don’t

work. Controls dampen domestic production bcause they lower farmers’ profits. In response, farmers naturally turn to growing non-controlled crops or seek ways to avoid government oversight. At the consumer level, the results are hoarding, shortages, and black markets. To prevent these consequences, the government is forced to provide deep subsidies. As the subsidies strain the government’s resources, the temptation to print money beomes irresistible, stoking the fires of inflation. When controls finally become unsustainable, an outbreak of inflation, in some cases, even hyper-inflation, is inevitable. This is just what happened in the United States in the early 1970s. President Nixon imposed a freeze on prices and wages for nearly three years to reduce the unacceptably high 4% inflation rate. By the time the controls were lifted, inflation was running at 10%.

Nothing breeds anger more than hunger. Food riots have broken out around the world in recent days, from West Africa to the Carribean, from Egypt to Indonesia. In a widely quoted remark, World Bank President Robert Zoellick, said, "The World Bank Group estimates that 33 countries around the world face potential social unrest because of the acute hike in food and energy prices. For these countries, where food comprises from half to three-quarters of consumption, there is no margin for survival."

For the past year, most of my commentaries have focused on housing and financial market issues affecting Americans. Serious as our current problems are, it can be useful to keep them in perspective. When government statisticians measure core inflation in the United States they exclude food. Changes in food prices are deemed too volatile to be useful in determining the true cost of living, and besides, Americans, on average, spend less than 15% of their income on food. What a luxury!

The Employment Picture Worsens

Non-farm employment declined by 80,000 jobs in March and previous months’ losses were revised higher.  All told, the economy has lost 232,000 in the last three months.  The unemployment rate rose to 5.1% from 4.8% in February.  One of the hardest hit sectors is construction, which employs 7.3 million American.  Here, the workforce has fallen 4.6% year-over-year.  Manufacturing has shed 2.2% of its workers and currently employs 13.6 million, about 9.9% of all working Americans.  Sub-sectors related to housing are also showing substantial employment declines, not only in manufacturing, but in finance and retail trade.

Job losses in the private sector of 286,000 have been somewhat offset by an increase of 54,000 government jobs. Governments employ 16% of the workforce or 22.4 million people. Of this group about 12% are in the Federal government, 23% work for the states, and 65% for local governmental units.  More than half of all state and local government workers are in education.  While government employment has held up so far, trouble is looming.  Declines in real estate and sales taxes are inevitable, and many governmental units will have to pay considerably higher interest rates for any new debt they issue.