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 / Spring 2007 / Issue 46(originally published by Booz & Company)


Joseph Ellis: The Thought Leader Interview

However, I have tried my methodology with a variety of larger retailers. For instance, when Wal-Mart became a $30 billion retailer in the mid-1990s, it became large enough that its business was tied to the national economy, at least to some extent, and real wages have in fact proved to be a decent leading indicator of Wal-Mart’s revenues. We also looked at the cyclical sales growth of Home Depot and Lowe’s. In those cases, unlike with Wal-Mart, we were not looking at general merchandise. They sell things that are affected by changes in the housing cycle. So we charted their sales against a series called “housing turnover,” the combination of sales of new homes and sales of existing one-family homes. And here we found a good leading relationship.

S+B: Most of the data in your book, and your examples, are American. Do you see the same cycle in other countries?
Yes, to the extent that I’ve been able to tell. Lacking a full-blown staff and not particularly caring to become an economics research house all by myself, I have run only the data for consumer spending, industrial production, capital spending, and employment in several developed economies: Great Britain, France, Germany, Canada, and Japan. In general, we find relationships among consumer spending, industrial production, capital spending, and employment to be similar to those in the U.S. But it has been difficult to find strong, consistent measures of real hourly wages that might be used to forecast consumer spending in these countries. Economists there might know or create better indicators and thus be able to make better forecasts using this approach.

S+B: You haven’t looked at, say, China or India?
Cyclical analysis is best applied to stable, modern, fully developed economies. If a country has exceptional growth and a huge net export or import balance compared to its home market, the close relationship between consumer spending on the one hand and industrial production and capital spending on the other might be altered considerably. The United States is an ideal place to apply the method because, despite our trade deficit, our net import ratio is still only 5 percent.

Now that I’m officially retired from Goldman Sachs, I maintain the updated charts for the overall U.S. economy on my Web site. But I don’t have the capacity to update them for overseas economies or particular sectors.

It’s crucial for businesspeople and investors to construct these charts and update them on their own. Even when I was an analyst, when clients asked me to interpret the data, I’d often show them the chart and ask, “Well, what do you think?” When lay businesspeople and investors undertake this kind of analysis themselves, it is often more sophisticated, by virtue of its very simplicity, than the analysis they’d get from a professional economist or from an analyst like myself. The single most important point is that you can do this analysis; you are not helpless.

S+B: How do you see globalization affecting the cycle?
That’s a really good question. Because imports and exports still largely balance each other out, I think that it’s not likely to change the value of these indicators in the U.S. in the short run. Imports in the U.S. still represent, net, only about 5 percent of our economy. But in the long run, if exports or imports on a net basis become 20 percent of our economy, then you would see a short-circuiting of the relationship between consumer spending and industrial production.

S+B: What do the charts suggest about the economic prospects for the next two years?
As always, everything depends on consumer spending, and that in turn depends on real average hourly wage growth and interest rates. Real average hourly wage growth was in a protracted downturn from 2002 through 2004, offset by the 2003 tax cut. Then it rebounded somewhat in 2006 with declining energy prices. But because of the unusual degree and extended period of consumer borrowing, particularly on homes, consumer spending did not reflect the full effects of that earlier decline in purchasing power. We had never before been through a period where consumers consistently spent more than they earned — that is, we had a negative savings rate — and I suspect we’ll have to pay the piper, cyclically, at some time before the end of 2008. Also, if interest rates go up much from here, then a very difficult scenario is conceivable. But the fact is that, as of late 2006, real wages are coming back a bit and even interest rates seem more benign than you’d expect at this stage of the cycle.

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