from Jeremy Gaunt:
Twisted Sister and the Federal Reserve
The Federal Reserve's "Operation Twist" has set the literary- and musical-allusion juices flowing. It is all about the Fed selling or not rolling over short-term debt and buying long-term bonds instead in order to keep borrowing costs low.
But that is frightfully dull for economists, analysts and reporters trying to get attention for their work. So, so far we have heard:
-- "Let's Twist Again", a reference to the 1960's Chubby Checker record about the dance craze . Problem is that the second line is "Like we did last summer", and the Fed did nothing of the sort, launching plain old quantative easing instead.
-- Twisted Sister might be a contender, but the heavy metal band's big hit "We're Not Going To Take It" probably better descibes market reaction to euro zone debt-crisis policy.
-- "Twist and Shout", a reference to the rock song covered by The Beatles, among, others. This is better. "Well, shake it up, baby, now" could indeed be the clarion call from financial markets for the Fed to so something, almost anything. But "Come on and twist a little closer, now, and let me know that you're mine" might be going a little far.
-- So the prize for now goes to literature not music: "Oliver Twist". Young Master Twist's "Please Sir, I want some more" just about sums it up.
Any others?
from Reuters Money:
Retirement investors suffer as economy catches up to Wall Street
Retirement investors have struggled with a Jekyll and Hyde economy these past two years, where Dr. Jekyll lives very well on Wall Street while Mr. Hyde runs roughshod over a terrified Main Street.
On Main Street, the jobless rate tops 9 percent and 14 million residential mortgages are underwater – a figure Deutsche Bank thinks will hit 25 million, or 48 percent of all home loans, before the housing bust ends.
On Main Street, the economy hasn't respond to ultra-accommodative monetary policy. Near-zero interest rates don't matter because because there's so little demand for credit to hire people or to buy post-bubble real estate.
Meanwhile, free money has been great for Wall Street. The companies that created Main Street's problems through the reckless behavior that led to the financial crisis barely missed a beat, and they went right back onto the gravy train.
Now, the Jekyll and Hyde economies demand to be reconciled. The markets finally realize what Main Street has known all along: we're stuck in a grinding, recessionary economy with no end in sight. You can't even call what's coming now a double-dip, because the first downturn never ended.
Monetary policy is of limited use. Interest rates already are at rock-bottom; we'll probably see more easing soon, even though QE2 hasn't helped much. Meanwhile, fiscal policy has been focused in exactly the wrong area — deficit reduction rather than job creation and direct stimulation of the economy.
Of course, most Americans have a stake in both the Jekyll and Hyde economies – we live on Main Street, but our retirement money is invested on Wall Street. So the obvious question: what now? I'll be blogging about strategies for retirement investing all week, but here's my opening comment to those of us living in the Mr. Hyde economy, don't create a self-inflicted wound by selling out of panic during this plunge.
from Jeremy Gaunt:
The unsyncopated rhythm of central banks
The European Central Bank is off and running with its tightening cycle -- raising by 25 basis points last week and talking in tongues enough to persuade markets that another hike is coming by July. At the same time, the Fed -- despite some hawkish comments recently about QE -- isn't seen actually tightening for some time. Next year, actually.
Bank of America-Merrill Lynch is now wondering whether there is something wrong with this. " Surely one of these central banks is heading to a painful policy mistake? " it says.
Key to the question is the fact that U.S. and euro zone economics are not as far apart normally as one might think. Take growth, where there is a 0.6 positive correlation between the two across business cycles. Or inflation. The correlation there is even greater at a positive 0.75 over a whole economic cycle.
So the two economies are pretty correlated. But the United States is usually ahead in changing gears with monetary policy, with the ECB -- and its economy -- lagging.
BofA -Merrill notes that this pattern was shattered last week when the ECB went first. "Assuming both central banks continue to be as responsive to growth and inflation as they have been in the past," it writes, "the ECB’s sprint ahead of the Fed suggests something fundamental is no longer in sync."
There is no such thing as inflation
In 1987, UK Prime Minister Margaret Thatcher whipped up a firestorm of criticism from her opponents on the left when she told a magazine reporter that “there is no such thing as society”, only individual men and women, and families.
The interpretation of those comments remains fiercely controversial. From the context it is not certain the prime minister was clear what she was trying to say.
But according to one interpretation the prime minister was encouraging her listeners to look beyond the impersonal aggregate of “society” to the individuals behind it.
The distinction between aggregates and individual components is something the Federal Reserve should bear in mind as officials mull whether to launch a new round of asset purchases to keep inflation from falling further and stimulate the recovery.
Because in some sense there is no such thing as inflation, only a collection of price rises for individual items, some rising faster and some slower.
It is clear price increases do have a structural component. Policymakers and economists distinguish between a general rise in the level of prices (“inflation”) and relative price increases for individual items (Adam Smith’s “invisible hand” guiding the reallocation of scarce resources).
But in an economy characterized by uneven spare capacity, with bottlenecks in some areas and unused capacity in others, excess demand and inflationary pressures may not show up evenly. Even as all prices rise (inflation), price rises are likely to be largest in those parts of the system with the worst bottlenecks, while increases in areas suffering significant under-employment of resources lag behind.
In purely mathematical terms, inflation is relativistic, and thus dependent upon reference frame. When conventional pundits characterize an economy as “inflationary”, they are also making the simultaneous implicit statement that the value of currency is being deflated. Hence, inflating prices is, in relativistic terms, the same as deflating cash. What conventional pundits call “inflation” is, in absolute terms, a perturbation of the commodity value / cash value ratio in the positive direction. What is now needed is a new function which recognizes the sector-related variance in the commodity value/cash value ratio. Then, intelligent stimulus policies which are sector-specific could be designed.
U.S. recovery – a mixed scorecard
Ultra-low interest rates and massive liquidity injections have acted like a painkiller, stabilising the U.S. economy and preventing it from going into shock. But they have not cured the underlying problem of over-extended households and an economy dependent on increasing consumer indebtedness as its main source of growth.
The result is a highly uneven recovery. While many parts of the manufacturing and the service sectors are rebounding strongly, those most dependent on credit, particularly housing and autos, and others associated with them such as home furnishing remain depressed.
Low rates have largely solved the cash flow problem, at least for households that have remained in employment. But household balance sheets are still undergoing what is likely to be a long and painful period of adjustment that will continue to act as a drag on credit-driven spending for several more years.
It is not clear monetary or fiscal policy can help much more in these areas. It was precisely overspending on cars and homes that got U.S. consumers into such a disastrous financial position during the mid and late 2000s.
Households have no real income growth to finance renewed spending on big ticket items and lack the confidence needed to take on much more debt to finance extra consumption. Even if confidence somehow recovered, most lenders remain wary about the poor creditworthiness of potential borrowers and the weak state of their balance sheets.
NO BIG TICKET SPENDING
Charts 1 and 2 show how the major categories of consumer expenditure changed between Q1 2007, which was before the subprime housing crisis began to really bite, and Q1 2010.
The massive unemployment being paid out to millions is funneling any trace of economic growth. These “glorified welfare recipients” are getting almost all their previous salary and this fill continue for at least 2 years!!! Why would any of them seek employment?
Market should prepare for autumn rate “exit”
Could the first increases in short-term U.S. interest rates come much earlier than most forecasters expect, perhaps as soon as September or November 2010?
Past experience suggests rates begin to rise about 30-35 months after the trough in the manufacturing cycle (as measured by capacity utilisation rates).
In the last four expansions, before this one, rates started rising 27 months, 48 months, 33 months and 31 months after capacity utilization had hit its low point.
Three of these observations lie in a narrow range of 27-33 months. Rates rose after an average lag of 30 months. The fourth reflected the unusually sluggish recovery after the last deep downturn ended in January 1983. Rates did not start to rise until four years later in January 1987.
Including this very deep recession pushes up the average to 35 months. If the Fed’s behaviour follows past practice, policymakers will not begin to boost the federal funds target until the end of 2011 or even the first half of 2012. That would be around 30-35 months after the recent cyclical turning point in July 2009. It would give the economy plenty of time to reabsorb the slack created by the recession and for the expansion to prove itself self-sustaining.
But another way to look at the problem is to ask how much of the slack created by recession is re-absorbed before the central bank begins to tighten. In the last four recessions, capacity utilisation fell by 16.8 percentage points, 18.2 points, 8.2 points and 13.6 points respectively (an average of 14.2 percentage points).
The Fed announced its first rate increase when utilisation had climbed back by 11.7, 11.0, 4.0 and 4.8 percentage points respectively (for an average of 7.9 percentage points). The first rise came when about 55-60 percent of the slack created during the preceding recession had been reabsorbed.
Forget the past. The fed no longer controls lending. Savers control Lending. Shareholders control Executive Pay. A revolt is underway. Money is being pulled from banks because we won’t accept low interest rates. Proxy votes are voting control and pay away from Executives. The hardworking savers are now in control!
Real commodity prices and the U.S. rate cycle
– John Kemp is a Reuters columnist. The views expressed are his own. –
Commodity prices exhibit a strong cyclical component — though it can be masked when producers are carrying a lot of excess capacity.
The attached chart shows the real price of various commodity baskets (Jan 1980=100) overlaid by U.S. interest rates (discount rate, later funds target), and the business cycle (NBER Business Cycle Dating Committee).
Prices began rising well ahead of interest rates after three of the last four recessions. Commodity markets anticipated future increases in demand even as policymakers prefered to hold back while recovery became more firmly established.
The current price rebound is unusual only for its strength.
Part of the explanation is the increasing weight of China and other emerging markets in global commodity consumption. As a result, the U.S. business and rate cycles and those of the other advanced economies now affect less than half the consumption of many commodities worldwide.
Prices are geared to the global cycle, which is not captured by measures of industrial output and capacity in the United States and the rest of the OECD.
Locking up bank reserves is wrong policy focus
– John Kemp is a Reuters columnist. The views expressed are his own. —
Plotting an exit strategy and shrinking the Federal Reserve’s balance sheet has become a hot topic as policymakers try to underscore their commitment to price stability and markets ponder the risk of inflation.
But micro-managing the reserve base is a curiously inadequate way to respond to medium-term concerns about inflation. Interest rates (the cost of credit) and supervision (leverage) are broader, more appropriate tools.
It is irrelevant whether the Fed sells its assets back to the market. What matters is whether and when the central bank is prepared to raise the price of borrowing.
A NEW STORYLINE
Federal Reserve Chairman Ben Bernanke is expected to use his testimony to the House Financial Services Committee on Wednesday to outline plans for taking back some of the liquidity it injected during the crisis.
There is no suggestion the Fed wants to start reducing liquidity straight away. Rather the central bank hopes a credible plan for reducing it later will head off fears about inflation and keep bond rates and borrowing costs down.
The fed had better raise interest rates soon, because a there are a growing number of us with a lot of cash in the banks that are getting sick of letting everyone use our money for next to nothing in interest. What if we all withdraw it until we get better rates?? For every $1mil I have in the bank I control $10Mil in lending.
Sluggish investment will hamper recovery
– John Kemp is a Reuters columnist. The views expressed are his own –
Unable to rely on the wounded consumer, the outlook for U.S. growth in the next three years depends on business investment and exports to take up the slack when stimulus programmes wind down. Ultra-low interest rates will help. But with the economy struggling to work off a huge overhang of unused real estate assets, and not much sign of investment elsewhere, investment spending is set to remain sluggish, condemning the economy to a weak recovery in the medium term.
Federal Reserve Chairman Ben Bernanke and other senior U.S. officials have already warned the rest of the world can no longer rely on over-indebted U.S. consumers as the principal source of global growth. There is no choice but to rely on investment and exports to take up more of the burden.
But investment spending outside real estate has been very depressed over the last cycle; there is no reason to expect it to accelerate much before 2013 at the earliest. So despite signs of a significant cyclical improvement in manufacturing in the past couple of months, the medium-’term outlook looks weaker.
MANUFACTURING BASE STAGNATES Between 2004 and 2008, private sector fixed-investment averaged $2.125 trillion per year (16 percent of GDP), split evenly between spending on equipment and software ($1.025 trillion) and buildings and structures ($1.102 trillion), according to the Bureau of Economic Analysis.
Manufacturers accounted for just $188 billion (8.8 percent of the total), with a higher share of spending on software and equipment (15.8 percent) but only a tiny fraction of spending on structures (2.4 percent).
Their investment simply replaced the loss of asset values due to deprecation ($187 billion) as a result of wear and tear, loss of efficiency with aging, and technological obsolescence. There was no net increase in the manufacturing sector’s capital stock.
from The Great Debate UK:
You never know when rates will rise
-David Kuo, Director at the financial website The Motley Fool. The opinions expressed are his own.-
Go on. Admit it. You didn’t see it coming, did you? You never thought a member of the G20 nations would dare to break ranks and raise interest rates this soon.
But Australia has done just that. The Central Bank of Australia has increased the cost of borrowing by 0.25 percent to 3.25 percent. It is doing what it thinks is right for the country regardless of what the rest may think. Now, Asian countries, keen to avert another bubble, may follow Australia’s lead and ratchet up interest rates before long.
Of course, Australia’s economy is vastly different to the UK’s. It has huge deposits of iron, aluminium and nickel that are in demand by mineral-hungry China. That said, Australia did briefly flirt with a downturn, which it successfully corrected with 21 billion pounds of fiscal stimulus.
But the UK is not Australia. We do not have huge deposits of mineral, and we are not near fasting-growing Asian countries either. What we do have are consumers saddled with over a trillion pounds of debt following a decade of binge borrowing, and a national debt burden of similar magnitude. Therefore, it is unlikely that we will experience demand-led inflation. In fact, consumers are saving more of their household income than they have done for eight years.
The most recent Office for National Statistics report shows that between March and June British households saved 5.60 pounds out of every 100 pounds of household income. That is very different from the first three months of 2008 when we not only failed to save any money, but we even borrowed 50 pence for every 100 pounds of household income.
That said, we are still some way off getting our overstretched household finances back on an even keel. So, the savings ratio could go higher. In fact, it is still some way short of the long-run savings-ratio average of 8 percent of household income.
