DRI-364 for week of 9-23-12: Revisiting the DRI and Related Economic Indices

An Access Advertising EconBrief:

Revisiting the DRI and Related Economic Indices

Periodically this space has revisited Access Advertising’s Driver Recruiting Index (DRI). This index tries to estimate the real-time ex ante demand for commercial drivers. It samples the classified ads placed to recruit drivers in 32 geographically dispersed major-metropolitan newspapers throughout the U.S. Every now and then, we place the DRI alongside other trucking, transport and freight indices and gauge its movements in relation to indices of overall income and employment.

The DRI in the 2nd and 3rd Quarters

Like the overall economy, the DRI got off to a reasonably fast start after a promising end to 2011. But it soon became clear that, like the U.S. economy, the DRI was going to fall short of expectations (let alone hopes) in 2012. The Index pierced the 200 barrier for the only time so far this year on March 25, flirting with a raw score of 500 (an achievement it exceeded 14 times in 2011).

After that, it has been all downhill. Year-over-year comparisons have occasionally fallen over 20% short of 2011; 10% shortfalls have been commonplace. Driver demand has never really caught fire, peaking in late spring and skipping both the normal summer high and the fall upturn.

Second-quarter GDP growth was also disappointing, ending up at a tepid 1.7%, even below the moderate 2% in first quarter. Although unemployment has now declined fractionally to 8.1%, this reflects only the decline in the size of the labor force. The number of new jobs created has continued to languish.

The only good news has been a Wall Street rally engineered largely in response to the latest quantitative easing by Ben Bernanke’s Federal Reserve. This is probably responsible for a recent upsurge in consumer confidence in the economy.

The DRI as Economic Indicator

If the DRI’s disappointing performance has mirrored that of general economic indicators, this very congruence speaks well for the DRI’s performance as an economic indicator. Trucking handles some two-thirds of all freight by volume and about 80% by value; many production inputs and final goods travel the nation’s roads and highways. We expect changes in trucking activity and driving demand to track overall trends in production, income and employment. (Whether the DRI is or should be a leading, coincident or lagging indicator is a complicated question that will be broached later.)

The DRI continues to display other desirable properties as well. One of those is (relative) stability. The very ubiquity and prominence of trucking strongly suggests that we should not expect to find the Index fluctuating widely from week to week. While trucking firms ordinarily experience high rates of turnover, this is a long-term phenomenon, responsive to demographic factors (average age, cultural shifts) and cyclical variables (wage changes, politico-regulatory changes). A particular trucking firm may well experience a sudden, substantial need for drivers, but this will usually represent a geographic shift of demand that is offsetting in the aggregate. Significant increases or decreases, when they occur, are usually persistent, cyclical changes in trend, not random fluctuations.

For a concrete illustration, compare the DRI with TransCore’s DAT North American Freight Index, which compiles data from the company’s load board network in the U.S. and Canada. Neither the DRI nor the NAFI is seasonally adjusted, but the contrast in variability is stark. Earlier in 2012, NADI racked up this record of month-over-month fluctuations: March 2012 – up 40%, April 2012 – up 3.5%, May 2012 – up 1.7%, June 2012 – down 2%, July 2012 – down 20%, August – up 1.1%. Monthly fluctuations of 20% in the DRI would be observed only at a seasonal or cyclical peak or turning point, and a 40% monthly change is unheard of.

The DRI and Comparable Economic Indicators

Given the importance of trucking in the production chain, it is surprising that the DRI is one of few time-tested, reliable trucking indices – and the only one to track driver demand. A rundown of the others reaffirms our understanding of what makes for a good index and confirms the DRI’s recent congruence with its brethren.

The Cass Freight Index compiles data from the expenditures of 350 of the largest freight shippers. Early in the year, the Index flexed its muscles with a 2.5% increase in February 2012. Then, along with the economy at large, it began to lose vitality. Increases diminished to 2.1% in March, 1.9% in April, 1.8% in May and 1.3% in June. In July, the Index turned negative with a 0.1% decrease, followed by a 1.1% fall in August. Sponsors and analysts cited a buildup of inventories, a fall in international trade and recent declines in manufacturing output as recorded by the Institute of Supply Management’s index, which had fallen for three straight months.

The American Trucking Associations are the Establishment of the trucking industry and Chief Economist Bob Costello is the voice of starched, high-collared authority. The ATA Truck Tonnage Index is perhaps the most widely cited trucking index, not only by private-sector analysts but even by the federal government. Although the ATA’s respect for authority imparts a big-government bias to its occasional obiter dicta, its economic data are accorded the utmost respect.

The TTI’s recent numbers paint the same by-now-familiar picture of a stalling, sluggish trucking sector. March saw a 0.2% increase, April improved to 1.1% but May backtracked to 0.9%. June went back up to 1.1% but July was unchanged. Typically, Costello’s public comments wrapped the language of an economist inside the rhetoric of a politician. He depicted “…an economy that has lost some steam but hasn’t stalled.” The ATA’s corporate commentary was more telling, noting that “…the index… has been moving mostly sideways in 2012.”

The Truck Tonnage Index is an important component in the federal government’s Transportation Services Index (TSI), which is published by the Bureau of Labor Statistics (BLS). For most of 2012, this index has alternated back and forth with little net increase to show for the year. In February, the TSI rose 0.5%, but it fell back 0.8% in March. April brought a modest rebound of 0.2% but in May the Index was unchanged. June and July saw offsetting 0.1% changes.

These indices display the bedrock virtues noted above: stability and congruence with general economic activity and with each other. One of the rising economic forecasting stars of recent years was the Ceridian Pulse of Commerce Index (PCI), compiled by respected econometrician Edward Leamer of UCLA. After recording some lackluster increases earlier this year, the Index ceased publishing somewhat mysteriously following its May release. Ceridian has responded to queries by saying that although the Index does not now publish its results, it is contemplating a return on a subscription basis and is soliciting indications of interest among potential customers.

Is the DRI a Leading, Lagging or Coincident Indicator?

Undergraduate students of economics are taught that economic indicators come in three flavors – leading, coincident and lagging. These indicate whether changes in the indicator lead, accompany or lag changes in the general level of economic activity. Since the unknown future preoccupies our attention, leading indicators are especially studied and prized.

There has long been a casual presumption that trucking indices are, or at least should be, leading indicators. Disruptive phenomena like layoffs and unemployment are presumably necessitated by the accumulation of unsold goods. Since trucks carry goods and the inputs necessary to produce them, freight shipments should register the incidence of cutbacks in production and materials. This is the sort of logic that supports the categorization of trucking as a leading indicator.

Early in its life, though, the DRI was observed to be a lagging indicator. We rationalized this as the caution of recruiters, who – unsure and suspicious of the depth and duration of any increases in freight supply after the Great Recession – waited to verify the persistence of demand before incurring the fixed costs of hiring. In fact, similar behavior had been recorded in connection with the Index of Classified Advertising, an economic index that bears a strong family resemblance to the DRI.

Since leading and lagging indicators are at opposite poles, this plants a seed of skepticism about the traditional taxonomy of economic indicators. Further consideration should nourish that thought.

The inherent logic of leading economic indicators says that they can be used to predict the economic future – or at least the turning points of business cycles. And this is simply impossible.

Anybody who can accurately predict the future onset of a recession – or, for that matter, the end date of one – can earn a fortune by so doing. Anybody who can repeat the performance reliably can become fabulously rich. Business forecasters are not fabulously rich. Ergo, they cannot predict the beginning or ends of recessions. Not reliably, anyway.

This must mean that leading economic indicators do not really lead. Maybe they don’t even indicate. In any case, something isn’t quite kosher. The question is: what?

The Theory of the Business Cycle – Such As It Is

Something else that all undergraduate students of economic statistics and econometrics learn is that economic theory and logic form the basis for all empirical work. Without theory, we cannot know what data to collect or what relationships to posit between the variables that make up the data. So an economic model is borrowed or created to embody the relationships upon which data is collected. Only then can the data gathering and testing begin.

But in business forecasting that runs us smack up against a formidable obstacle. There is no generally accepted business-cycle theory. The categories used by the National Bureau of Economic Research to codify episodes of the business cycle – expansion, peak, contraction and trough – were developed by institutional economist Wesley Mitchell in the early 1900s, based on years of observation and study of past recessions. Unfortunately, observation is not theory.

The national income and product accounts used to compile U.S. economic data were developed later, based largely on the economic categories developed by English economist John Maynard Keynes in his influential work The General Theory of Employment Interest and Money. But Keynes explicitly denied that the General Theory contained any theory of the business cycle. He simply declared that capitalist economies suffered from a chronic shortage of aggregate demand – e.g., private spending by households and producers. He never said why the shortage existed. Government should make up for this shortfall, Keynes maintained, by running budget deficits that increased the aggregate total of aggregate demand or spending. Essentially, government should commit to purchasing whatever volume of output is left unbought by households and producers, so as to insure full employment. Keynes didn’t supply a theory to account for the business cycle, only a purported remedy to cure the symptoms.

Without knowing where the shortfall in spending lies, we cannot predict where to look for leading indicators at any stage of the business cycle. There is one school of thought whose business-cycle theory offers general advice on this point. That is, it doesn’t offer a list of specific industries, sectors or indicators as such, but instead provides advice about where to look for them in general cases.

The Austrian theory of the business cycle pinpoints monetary expansion by government – probably supervised by a central bank – as the proximate culprit behind recessions. By driving interest rate below the “natural rate of interest,” the rate that would equate the saving households and producers want to do, the money creation will make interest rates artificially low. This makes long-lived, capital-intensive production processes artificially attractive to producers. In turn, this creates a “bubble,” or artificial excess prosperity, in the sector thus favored. While it lasts, this bubble can seem deliriously prosperous, almost too good to be true. That is because it is too good to be true, as the drawn-out period of housing prosperity in the U.S. proved. But when the bubble bursts – owing either to a rise in interest rates or a rising burden of debt – the artificially-prosperous sectors are the first to crash. They are the leading indicators of the coming recession.

In general, then, leading indicators are those pertaining to the sectors receiving the artificial encouragement. In the U.S. during the 1990s and early 2000s, this would have been the housing sector. But this does not mean, as many have implied or outright insisted, that the housing sector should be the first to recover its balance. And it does not mean that nobody can recover until the housing sector does. Indeed, the reverse is more nearly true – housing should be the last sector to recover fully. It also means that the stubborn attempts to stage-manage recovery in housing by holding interest rates low and artificially raise housing prices through government purchases of mortgages and securities are counterproductive. After all, this is exactly the process that caused the problem in the first place – repeating it merely enlarges the backlog of adjustments that must occur before recovery can take place.

An Austrian Look at Economic Indicators

The effect of this theory on forecasting practice is striking. Housing becomes a leading indicator for the downturn phase because it is a long-lived production process, extremely sensitive to interest rates. But it is a lagging indicator for the upturn; it cannot recover until all of the bad investments made during the bubble phase are liquidated and their resources reallocated.

What about trucking? Well, trucking feeds the housing industry its materials and some of its manpower, so trucking shares this dual forecasting status. Sometimes it will be a leading indicator, sometimes a lagging one. Moreover, trucking feeds other industries as well, so it simply cannot be pigeonholed by a simplistic taxonomy. A sophisticated approach to business cycles requires us to abandon our primitive definitions of economic indicators. First, we must classify industries and sectors according to their status in the production and consumption hierarchy. Second, we must recognize the difference between recession and recovery.

We have still not exhausted the reserves of analysis, since there is still the possibility of inherent cyclical movements in economic activity that are not driven by monetary mistakes made by the authorities. The fact that money substitutes for barter in allowing human beings to trade the product of their labors solves huge problems, but it also creates smaller ones. These subtle problems may well mean that we have to live with an unavoidable element of cyclical instability in our economic life. And this may demand still more adjustments in the terminology of forecasting.

Progress Report on the DRI

The DRI is completing its fourth year of operation. It has passed the standard tests of stability, reliability and usefulness that apply to economic indices. Of course, it has not unlocked the door to wealth and fame available to any economic index that could actually forecast the future – but, as we have seen, that is a chimera. Explaining the past and recognizing the present is tough enough and a worthy goal for any economic index. Many a worthwhile aspirant has fallen short of even this limited objective; Ceridian’s PCI may be the latest addition to this list.

Nearly four years in, the DRI is still trucking.

DRI-444: And the Beat of the Economic Greek Chorus Goes On

Early in 2012, broad indices of income and employment turned upward. Although not dramatic, the upturn raised hopes that at long last the economic recovery was about to shift out of low gear and into overdrive.

Of course, there were nagging problems with this optimistic scenario. For one thing, the transportation sector did not participate in the upturn. Trucking in particular languished. This seemed odd in view of the fact that roughly two-thirds of all freight travels by truck. While puzzled by this seeming anomaly, commentators like Edward Leamer of UCLA voiced optimism that trucking would soon get with the program. And it seemed unlikely that the pace of trucking activity could long lag that of the general economy.

Well, one quarter later, trucking’s rate of growth has lined up with that of the overall economy. But convergence has not been effected by a growth spurt in trucking. Instead, it is the overall economy that has dropped back into line with the dismal growth rate of the trucking sector.

What might account for the seemingly inexplicable pattern of economic fluctuations that have plagued the Great Recession and its stunted offspring, the Little Recovery? Can we identify the keynotes that distinguish this Great Recession from past business cycles?

The Greek Chorus on the Economy

In ancient, classical drama, the Greek chorus served the function of narrator and commentator on the events depicted. Over the last few years, economic commentators have formed their own Greek chorus. This suits the dramatic quality of world economic history ever since the financial crisis of 2008 – crisis following crisis, the major industrial nations bleakly eyeing a wall of worry. No sooner has one fraught moment passed than another pops up.

The Greek Chorus may be theatrically effective, but they are analytically deficient. They lack the experience and assurance needed to ad lib an explanation for this, the least conventional business cycle of them all.

The traditional model of the business cycle posits wave-like movements of economic activity joined by high (peak) and low (trough) points. The falling portion of the wave is the contraction phase. The rising part is the expansion. This roughly corresponds to the experience of living Americans. But the current Great Recession is new and different.

At the outset, the recession began in December 2007, but few would have made book on its existence until the meltdown came in the fall of 2008 – at which point the economy nosedived like a crooked prizefighter. The official end of the recession in June 2009 came and went without notice; unemployment remained sky-high for months afterward.

Eventually, it became apparent that a recovery was underway. Make that an apparent recovery – two or three months of modest growth was succeeded by a backslide in income and employment. This is hardly a classic business cycle scenario and it’s no way to run a railway to economic growth. You can travel between two points by dancing a box step but it’s not an efficient way to traverse the distance.

But the Greek Chorus could only sing its part from a script. It could moralize about the Greeks and their woes, and how those woes would wound the West if we weren’t careful. It could sing about morality – greed and inequality and protest and such. It could narrate a familiar tale about the business cycle. But it couldn’t analyze. It lacked a theoretical framework in which to look beyond history and tradition to ask why this episode differed from all that had gone before.

The Greek Chorus Sings the Same Song, Different Verse

In the fourth quarter of 2011, the U.S. economy achieved annualized growth of 3.0% and unemployment fell to 8.3%. The Greek Chorus raised its voices in hosannas of praise and thanksgiving. In January, employment jumped further. This was an “unmistakable” sign that we had turned the corner.

Alas, first quarter of 2012 simply repeated the same song heard ever since 2009. This verse featured reduced annualized growth of 2.2% and slightly lower unemployment, culminating in an 8.1% rate in April, 2012.

Unfortunately, even a lower unemployment rate became a mixed message. While the number of unemployed persons fell by 175,000 between March and April, 2012, the number of employed persons also fell, by 165,000. The job gain of 115,000 was well below the 200,000 job gain usually considered necessary to absorb increases in population and labor-force growth in a typical month. Of course, this month was anything but typical – the civilian labor force fell by 342,000. Since the unemployment rate is calculated by dividing the number of unemployed (12,500,000) by the total number of people in the labor force (154,365,000), the resulting 8.1% was only a razor-thin improvement over the previous month (12,675,000 divided by 154,707,000 equals 8.2%). The total number of employed people was 141,865,000 – up from 137,968,000 in December 2009 but well behind the 146,595,000 in 2007, before the recession started.

Once again, the “unmistakable” signs of recovery had become mistakable.

Why the Greek Chorus Sings Off-Key

In its narrative role, the Greek Chorus is not performing but instead “phoning in” its performance by relying on pre-digested Keynesian platitudes and bromides, as if it had substituted a pre-recorded instrumental for live performance. And that instrumental is like an old phonograph needle stuck in a crack, playing the same notes over and over again.

The Greek Chorus excoriated Wall Street for the failures of its “rocket scientists,” who developed complex derivative securities and relied on statistical databases to develop safety ratings for mortgage-backed securities. Rightly so, for radically changed credit standards had made the databases worthless for evaluating creditworthiness in today’s environment. But now the Chorus fails to recognize that the textbook business-cycle model cannot describe today’s reality, in which policymakers manipulate markets in vain efforts to make miracles or buy time in which to maneuver.

The simple business-cycle model only worked when markets were allowed to work. Today, the economy functions like an automobile whose fuel supply is impaired by some flaw such as a clogged filter. The vehicle lurches forward, stutters, stops, and lunges forward again. Something is obviously wrong, even if the source is not quite clear.

Insofar as they have any economic training at all, most people are trained to look to aggregate demand, or total spending, as the key to all mysteries. But that is not the problem.

In a functioning economy, markets tend to reconcile diverse perspectives of different people by providing objective knowledge about reality. People rely on that. Each of us knows that we don’t know everything, so we rely on what markets tell us and we rely on our ability to get information on the future and in the future. We can’t do that today because we all know that today’s economy is not “real.”

The best example is the “zero interest rate” policy (ZIRP) followed by the Federal Reserve. Everybody knows that interest rates do not reflect the actual saving and investing desires of consumers and businesses. We all know that ZIRP cannot go on forever, and when it ends the interest-rate environment will change drastically. We know that all those drastic changes will have tremendous effects on most of the economic choices we make now and in the immediate future.

In effect, most of the country is living with one ear attuned to daily life and the other one keenly listening for the other shoe to drop – that is, for any sign of the change that we know is coming. Obviously, we can’t live in a state of suspended animation. But just as obviously, it’s in our interest to do the minimum necessary to get by until this state of massive uncertainty clarifies.

And guess what? Everybody “doing the minimum necessary” translates into an economy with minimal growth and confused direction. Long-term investment is attractive only when the circumstances are absolutely ideal – or when political corruption or cronyism tips the scales in favor of action. Hiring is analogous to long-term investment because it entails assumption of so many costs and because firing has become correspondingly difficult. It’s no wonder, then, that we’re in the fix we’re in.

Waiting – But Not for Godot

Some other paralysis-inducing factors are related to ZIRP. Current and future projected spending at the federal level is producing unprecedented peacetime accounting deficits. These require federal borrowing. Interest payments on the necessary bonds threaten to eat up the entire federal-government budget before the decade ends. Everybody knows that this process cannot continue. Everybody knows that its termination will require massive dislocations. Some of these might be large spending cuts, huge tax increases, elimination of federal-government agencies and departments, privatization of government functions, and large-scale reductions in federal employment. Nobody can dispute the stunning impact of these measures. Everybody is waiting to see what will happen.

Many state and local governments are in bad financial shape as well. Included among them are some of our largest and most populous states, such as California, Illinois and New York. Most people realize that the promises made to many public-employee unions regarding retirement pension and health-care benefits have placed government finance in an untenable position. Once again, the necessary remedial actions will have dramatic effects on all the affected parties. Everybody is waiting to see what will happen.

In Europe, Americans can watch a preview of coming distractions. The European welfare state is imploding. Whether the implosion becomes an explosion will depend on where the charges are set and on their strength. Greece is facing default on its public debt and withdrawal from the European Monetary Union. In an unprecedented action, Spain is about to bail out its largest bank. Everybody suspects that the stronger European countries are rapidly running out of time to deal with the depredations of the weaker ones. Deep in our hearts and heads, we know that Germans will not work until age 67 so as to pay higher taxes whose revenues will allow Greeks to retire at age 50.

We are waiting to see what happens.

The Federal Reserve has created astounding amounts of money by purchasing both new and existing federal debt. Instead of entering the flow of income and expenditure via the loan process, most of this created money has sat on bank balance sheets in the form of excess reserves, drawing interest paid by the Treasury. This policy was deliberately contrived by the Fed and Chairman Bernanke, presumably because of fears that many banks required bolstering to forestall insolvency and couldn’t be expected to bear the risks of normal operations. Everybody knows that this situation cannot continue indefinitely. Everybody knows that if this flood of money is injected via the usual loan process, hyperinflation will result. Everybody knows that hyperinflation would throw the U.S. economy into chaos. We are waiting to see what happens.

Tune Out the Greek Chorus

All this “waiting to see what happens” is frighteningly real. It cannot be quantified into a simple model like the Keynesian multiplier of income and expenditure, so it is beyond the ken of the Greek Chorus. It requires economic analysis of a kind that went out of fashion at the point when economics became “scientific” by relying exclusively on mathematics and statistics. We are beset by radical uncertainty, a term that is qualitative rather than quantitative. We cannot meaningfully assign probability values to possible outcomes, so the so-called economic theory of uncertainty is mostly useless here.

The solution, counterintuitive though it may be to so many of us, is to step back and allow markets to work. Every single source of radical uncertainty listed above is caused by policymakers either trying to overwhelm the market or trying to buy time to decide what to do next. Only time and markets can lift the fog of uncertainty, because only markets can generate and collate the objective information necessary to dispel the uncertainty that currently paralyzes us. In the meantime, we should ignore the Greek Chorus. If necessary, use earplugs.