It Depends

One of the current success stories of late for Rhode Island has to be retail sales. Not only has retail sales been in a well-defined uptrend since the last quarter of 2009, at the present time it is very close to its highest level since 1990.

Retail sales can be either a coincident or lagging indicator, meaning that it either reflects what is going on at the present time or what has recently occurred. For Rhode Island, the most timely data on retail sales is that for retail sales subject to the sales tax. Based on when these taxes are paid and recorded here versus when the sales actually took place, retail sales for Rhode Island is a lagging indicator. Also, retail sales is a very cyclically sensitive indicator, which means the value of retail sales is very sensitive to the overall level of economic activity. The technical term for this is that retail sales are pro-cyclical, since they move in the same direction as the economy.

Like any economic indicator, it too has its limitations: since this is based on retail sales tax collections in Rhode Island, it excludes any items that are not currently subject to taxation, most notably clothing. And there can be distortions. For example, given the very mild winter, winter clothing expenditure very likely fell since the same time last year. If that decline was sufficient to move total retail sales lower than they were last year, the understatement from excluding clothing sales from our sales tax data might not be as large as it typically is. Similarly, since the meals tax in Rhode Island has been 14.7% higher than the regular sales tax rate for several years now, this has distorted "retail sales" for meals over this period -- tending to overstate the overall total. While this may sound like minutia, it is important to understand that every economic indicator has its share of "baggage." I have believed for quite some time now that the indicator any person likes best is probably the one that person knows the least about.

Let's take a look at the historical performance of retail sales in Rhode Island, using as our basis quarterly data on retail sales subject to the sales tax expressed at an annual rate. The chart below (click to enlarge) shows values since the first quarter of 1990. Please note that the vertical axis is stated in logarithms, mainly because a given vertical distance represents the same percentage (relative) change between any two period in the chart.

The most recent peak in retail sales occurred in the fourth quarter of 2006, at $12.7 billion. Can you think of anything else that happened that quarter (hint: we have discussed this numerous times in prior posts)? The answer: it coincides with Rhode Island's most recent employment peak. This reflects the fact that retail sales are very sensitive to the overall level of economic activity, as stated earlier. The trough for retail sales was in the fourth quarter of 2009, at $11.2 billion. Thus, Rhode Island's peak-to-trough decline in retail sales was 11.8 percent. Note that retail sales have trended upward throughout this recovery, although not straight up. Once again, the cyclical nature of retail sales is in evidence here.

This chart provides an excellent illustration of the mindset of most, if not all, of Rhode Island's leaders, its media, and its residents: things here have now turned around nicely, and Rhode Island is doing much better it has in a very long time. Add to this the fact that income tax revenue is up, at least above expectations, and if you read my last post, employment is apparently higher and our state's jobless rate is lower than the currently published data indicate. Thus everything appears to have returned to normal.

I agree totally with the assessment that everything here has returned to normal -- but Rhode Island's "new normal." In economics, we never look at things in absolutes. Instead, we always evaluate things in relative terms. This precludes our making substantive judgments about the behavior of indicators that are stated in current dollars, as retail sales is above. So, let's now turn to evaluating retail sales here in relative terms -- meaning relative to the purchasing power of the present time. This, recall, means examining the historical behavior of real retail sales.

The next chart shows the behavior of real retail sales subject to the sales tax for Rhode Island since 1990 (click to enlarge). As should become readily apparent almost immediately, this gives a very different picture of our current situation.

When taking inflation and purchasing power into account, the peak in real retail sales occurred in the third quarter of 2004, at $14.8 billion. This peak thus came well before the current dollar peak (in 2006Q4). Note that by stating retail sales in the purchasing power of Q1 in 2012, we are "inflating" current dollar values from earlier periods into what they would be if dollars then had the same purchasing power as today, which explains why earlier current dollar values are higher when stated in real terms. The trough in real retail sales occurred in the fourth quarter of 2009, at $11.9 billion. This is the same quarter as the trough in current dollar retail sales.

The reality of Rhode Island's current situation, our "new normal," to quote the phrase coined by Mohammed El-Erian of PIMCO, is in fact very different from the predominant view of our state's economic performance. First, real retail sales here have been falling since the third quarter of 2004, well before our most recent employment peak. Second, the peak-to-trough decline in real retail sales here was much greater than one would conclude based on current dollar values, just under 20 percent. Third, while real retail sales have improved since their trough in 2009Q4, they have registered almost no gain since that time: $12.1 billion versus $11.9 billion. Finally, the most recent trend in real retail sales is sideways to downward. Thus, Rhode Island's economy has failed to perform well enough to consistently generate retail sales growth rates in excess of inflation for quite some time now.

Where does all of this leave us? Not where almost everyone in this state appears to believe. Retail sales data, when viewed in the correct context of real values, confirms something I have written about in more posts than I care to think about, that Rhode Island is in a very tepid recovery. So, even when (or if) current dollar retail sales here exceeds it recent high of $12.1 billion, we will not have returned to anywhere even remotely close to where we once were. So, do we continue to contrast the current situation with the depths of where we once were, as seems to be the dominant view, or should we shift our focus to where we are relative to recent heights? You can guess which I will continue to opt for.

We should be attempting to move toward recent highs -- that should be the standard of excellence or satisfactory performance here. And, guess what? That outcome doesn't just fall on us from heaven. We have to work for it. And very often, this will require that we work very hard to get there. I heard a great saying a few months ago that pertains to this: "Success is not a destination, it is a journey." It's time for Rhode Island to purchase its ticket for this journey, because the dominant perspective here, to dust off an old phrase I used to use to describe Rhode Island about a decade ago, defines success in terms of "Relative Mediocrity."

A Chart of the Future Direction of Rhode Island's Economy

It has been abundantly clear from the performance of my Current Conditions Index over the past several months that Rhode Island's economy has continued to slow. As of the most recent report (August 2011), I reported that Rhode Island is essentially at "stall speed."

To understand what is actually happening at the present time, we need to revisit what occurred during the last recession. As that recession continued, the levels of many key economic indicators became so beaten down that they ultimately couldn't fall much further. So, the seeds for the present recovery began to emerge as our state's economy began to decline at slower and slower rates. I wish I could say that this was related largely to Rhode Island's leaders reinventing our state's economy and eliminating most of the structural weaknesses that continue to haunt us to this day. But, this is Rhode Island. The operating procedure of our state's leaders then, which continues to this day, can be summed up with a single word: Mañana.

Our long recession finally ended and economic growth returned around February of 2010, which is the date I place on the beginning of this recovery. As I have discussed in previous posts, this did not then, nor does it mean now, that we have returned to "normal" activity levels. What actually occurred is that the greatly diminished levels of many key variables eventually became relatively easy to beat. So, we finally began to beat these weak "comps," and we improved from there. Our rate of growth thus became positive, and for the remainder of 2010, Rhode Island's economy performed fairly well, certainly far better than it had in the prior three years!

What we are witnessing now is the "second act" of this play. We were able to handily beat the weak comps throughout 2010, but for this recovery to continue, we have to beat ever-improving comps through time. For this to occur, our rate of economic growth must be sustained or even accelerate, and the breadth of overall economic activity must expand.

As my Current Conditions Index shows, CCI values for 2011 have lagged the corresponding levels for the prior year since March. Thus, our economy's rate of growth has continued to moderate. Given the values for July and August, there is even some question in my mind as to whether there is much growth at all.

An excellent way to see the manifestations of the above discussion is to view Retail Sales for Rhode Island. As I have done on other occasions, I converted this to its real (inflation-adjusted) value, since Retail Sales is in current dollars, and its behavior can be distorted by inflation. The chart below shows this since 2007 (click to enlarge):

The first thing that should jump out at you is how far real Retail Sales today are below their peak in mid-2007. This is not unique to Rhode Island -- the levels of many variables today remain far below what they once were in the "good old days" of leverage and debt accumulation. Focusing on the present recovery (the blue shaded area), real Retail Sales have been largely range bound, displaying lower highs throughout this entire recovery, with a floor (or "support") around the $11.6 billion level.

It is this indicator, Real Retail Sales, that can serve as the proverbial "parakeet in the coal mine" with respect to the future (cyclical) direction of Rhode Island's economy. Based on the way this indicator has behaved throughout this recovery, there will either be a breakout above the red line (resistance) or a breakdown below the green line (support) in the coming months.

A breakout, which is what we should all be hoping for, will indicate that the present recovery is continuing. For this to occur, it will be necessary for employment to continue rising, which at the present time means that it returns to an uptrend. Along with this, tax revenue would continue to provide us with pleasant surprises, helping us moderate budget deficits.

A breakdown, the dreaded outcome, would reflect that our state's economy is unable to sustain its current growth and breadth of activity, meaning that we are headed into a double-dip recession. This would be accompanied by falling employment, increasing unemployment, declining tax revenue, and a rising budget deficit. The actions required to restore budget balance would inevitably further slow the pace of economic activity.

So, the ultimate question is which way is Rhode Island headed? Had our leaders used the past crisis ("The Great Recession") to reinvent our state's economy, making it more competitive with greater exposure to growth-oriented sectors, the most likely outcome for us would have been a breakout above with continued recovery. While a crisis is a terrible thing to waste, the inaction of our state's leaders, guided by their primary leadership principle -- Mañana, means that Rhode Island wasted the opportunity afforded it during the last recession to make meaningful structural changes to our state's economy. We once again find ourselves "flat footed," largely at the mercy of national and global economic momentum.

Ironically, the world has changed -- national economic momentum is largely influenced by global trends, especially what is occurring in Europe. So, even the US is no longer the master of its own fate. The real question for us thus becomes exactly what is it that Rhode Island is the master of?

Have Rising Energy Prices Hurt Retail Sales in Rhode Island?

By now, just about everyone is aware of how burdensome the ongoing increases in food and energy can be. Sadly, our pay doesn't keep pace with these rising costs, so on an inflation-adjusted basis, income is actually falling (economists refer to this as real income). The result of declining real income is that one particular area of spending, discretionary spending, is hit very hard. Why? Because discretionary spending, spending that one really doesn't have to do, but would like to do, is generally predicated on either having extra purchasing power (i.e., higher real income) or using credit. Home equity is largely gone as a basis for credit, and many people are either unable or unwilling to add to their credit card debt. So, spending patterns adjust and the extra boost that discretionary spending gives to the economy begins to dissipate.

A scary factoid I recently read about concerning this is particularly disturbing: according to Walmart, spending by their customers at the end of each month has been dropping very sharply of late. Apparently, many of their customers simply run out of money by month's end! I honestly don't recall seeing anything that drastic in a very long time, if ever. This is clearly a sign of the magnitude of the problems the US is facing.

What about Rhode Island? Is there any empirical evidence that retail sales here have been hurt by higher energy prices? Sadly, the answer is yes. To explore this, I converted retail sales into their inflation-adjusted (i.e., real) values. I then contrasted the rates of growth in real retail sales for Rhode Island with growth rates in gasoline prices. To make this less volatile and to make it easier to visualize the underlying relationship involved, all growth rates compare values in a given month to the same month one year ago (called year -over-year, denoted Y/Y). The chart below (click to enlarge) shows the results.

To put this into context, the economic impact of rising energy prices depends on both the levels to which they rise and how rapidly they increase. The more rapid is the rate of increase, the less able are persons to adjust to the changes they are confronted with. The rate of increase in gasoline prices is shown in the chart as a rising red line as of June 2010.

First, and foremost, the negative effects of rising gasoline prices are not instantaneous. Thank God! It takes time for rising gasoline prices to significantly erode real income and hence the ability of persons to purchase goods. Also, it must be kept in mind that gasoline prices are not the only factor affecting real retail sales. Other factors also matter (employment, hours, etc.) so there will not be anything resembling a perfect correlation in a chart like this.

The chart shows that after gasoline price growth fell to very low levels by mid-2010, they began a sustained period of accelerating growth through March of 2011. Economic activity in Rhode Island improved during the second and third quarters of 2010 (based on my Current Conditions Index), which helped to offset some of the building negative effects of the more-rapidly rising gasoline prices. Note that there was a jump in real retail sales growth during the 2010 holiday season, in spite of the fact that gasoline prices had been rising at more rapid rates for a while by that time. But once the 2010 holiday season ended, I think of this as the "last hurrah" for retailing here, things changed. While real retails sales were still rising, their growth began to slow as we entered 2011. Eventually, real retail sales declined (their growth became negative) driven in no small part by the period of accelerating increases in gasoline prices. Retail weakness, should it persist, does not bode well for future economic growth here, and it won't help us to sustain recent pleasant surprises in retail sales tax revenue.

Where do we go from here? Recall that both levels and rates of growth in gasoline prices matter. So, while the rates of increase in gasoline price have recently slowed, the result of moderating global growth and some firming of the US dollar, the level of gasoline price is still relatively high, close to $4 per gallon. Absent major declines in gasoline price this summer, this stubbornly high cost of gasoline will continue to take its toll on economic activity here.

Timing can be everything. As Rhode Island's economy has been growing more slowly of late (based on my Current Conditions Index), repairing the damage from high and rapidly rising gasoline prices will take time, so don't expect any snap back of the rate of growth here. That would be true even if we didn't have the negative effects of budget deficits and the pension crises to deal with.