RealClearMarkets - Articlestag:www.realclearmarkets.com,2008:/articles//52008-07-01T18:10:23ZMovable Type 3.33The Zero at Ground Zerotag:www.realclearmarkets.com,2008:/articles//5.128952008-07-02T09:06:45Z2008-07-01T18:10:23ZThe terrorists who attacked the World Trade Center on 9-11-01 were striking a blow—a devastating one they hoped--at what they saw as the heart of capitalism and free markets in the United States. But in the aftermath of the attack, what the rest of the world saw was a wounded but game city that quickly pulled itself up off the mat--from the rapid return of the New York Stock Exchange, located just a few blocks from Ground Zero, to the speedy work of putting the city’s essential systems back on line and getting companies back to business.
But even as New York rebounded, a strange, parallel storyline emerged in the planning to rebuild on Ground Zero. Less inspiring, the themes of that story were resignation, a lack of faith in free markets, and a perplexing willingness to capitulate to those who would destroy the institutions that are at the heart of our democratic capitalism. There are many players in this parallel storyline, from urban planners who saw the wholesale destruction as an unprecedented opportunity to shape 16 acres of prime city real estate into their version of the 21st century city, which didn’t include a return of commerce, to advocacy groups who viewed the site (and the promise of billions of dollars in federal aid) as an opportunity to advance agendas for everything from subsidized housing to a kind of super urban arts community.
tamny
Unfortunately, too many political and business leaders lent credibility to this parallel story line. “America’s Mayor,” Rudy Giuliani, whose own actions had been so heroic on 9-11, seemed so consumed by the grief that, quoting from Lincoln’s Gettysburg address, he called for the entire site to become “hallowed ground” free from commerce. His successor, the businessman mayor Michael Bloomberg, displaying a pessimism about the future of the city’s economy that was astonishing in an elected official, argued that Lower Manhattan’s days as a commercial venue were numbered and the site should be given over to residential building. John Whitehead, the respected former chairman of Goldman Sachs tapped by New York Gov. George Pataki to head the rebuilding effort, seemed seduced by the far-fetched schemes of planners and wound up advocating that the site become the center of a tourism district revolving around 9-11--a proposal that smacked of turning Ground Zero into a Disneyland of Death.
All of these voices, and others, have conspired to give us what we have now, which is a site where, approaching seven years after the attack, all one can see for the most part are a bunch of cranes and other machinery moving around dirt. On Monday, the latest report on “progress” at Ground Zero (and one can only use that word in parentheses when referring to the WTC site) noted that virtually all of the work there is behind schedule and billions of dollars over budget.
The mismanagement of the site has produced a design for a new transit station that is so expensive and impractical to build that even with a $2 billion budget, it can’t be constructed, and probably never will. Meanwhile, the so-called “iconic” Freedom Tower, conceived with no practical commercial purpose in mind so that it will be occupied mostly by government agencies, is a year behind schedule. The construction of the 9-11 memorial dubbed Reflecting Absence--an elaborate but vapid design that commemorates nothing except the absence of those who died that day (with barely even a special nod to the police and fire officers who gave their lives to save others)--is also behind schedule after cost estimates doubled beyond the original $500 million projections. It’s now nearly certain that the memorial, reengineered to be on budget, will not open by the 10th anniversary of the attacks, while memorials at the Pentagon and in Shanksville, Pa., are already completed. One component of the Ground Zero memorial, an accompanying museum dubbed the International Freedom Center, won’t ever open. The redevelopment team shelved it because its content was so controversial.
At this point, the only commerce taking place on the former site of the World Trade Center is in the rebuilt 7 World Trade, which sat to the north of the twin towers and also collapsed that day. Owned by the developer Larry Silverstein, 7 World Trade was never part of the original 16-acre Ground Zero site controlled by the Lower Manhattan Development Corp., and so Silverstein was free to move quickly to rebuild without government intrusion. Shovels hit the ground in May of 2002, and the new, 52-story tower opened in spring of 2006. It boasts more than 1 million square feet of leased space to blue-chip tenants like ABN AMRO, Ameriprise Financial, and Moody's Corp.
Silverstein should be something of a champion of Ground Zero. Through all of the talk about abandoning commerce at the site and all of the political infighting and pie-in-the-sky planning, he was crucial in fighting to ensure that the 16-acre site didn’t simply become parkland, or housing. A year ago he told me, "The financial center's locomotive was the World Trade Center, and for the sustenance of the city and the region, we need to get those jobs back.” In addition to 7 World Trade, Silverstein has the right to develop three other towers on Ground Zero, although he’s had to wait for the agency controlling redevelopment to design a site plan and do the foundation work for the towers.
For his efforts, Silverstein hasn’t been celebrated, but demonized. The Vice Chairman of the Port Authority of New York and New Jersey, which controls the site, called him “greedy” for his tough negotiations with potential tenants of 7 World Trade, which dragged out the announcement of some leases. Mayor Bloomberg accused him of asking too much to lease up 7 World Trade—as if our politicians should be setting office leasing rates. One of the city’s tabloids, the Daily News, responded to Silverstein’s defense of himself with the headline Butt Out, Larry.
Yet in the end, Silverstein has given us the only real progress at Ground Zero. And he’s constructing the real memorial down there, the return of the marketplace on the site where the terrorists eradicated it. To achieve that, it isn’t Silverstein or the free market that should be butting out.
Has The WTO Reached a Tipping Point?tag:www.realclearmarkets.com,2008:/articles//5.128812008-07-01T18:18:49Z2008-07-01T14:23:20Z
The World Trade Organisation is losing its place at the centre of the global trading system. Absent reforms, the rules-based architecture of international trade may collapse into a “might makes right” affair.Brandon
A polycentric trading system?
No one knows what happens beyond the tipping point. My guess is that trade would continue to grow and the system would continue to function – but not equally well for all nations. Before the GATT was set up in 1947, the Great Powers settled trade disputes by gunboats or diplomats depending upon the parties involved. Only the naïve thought market access should be reciprocal or fair. A return to this “Belle Époque” extreme is unlikely, but a new Great Powers trade system is likely to emerge. Its core will be the US and EU networks of bilateral trade deals.
Domestic special-interest groups, newly freed from WTO constraints, would push the EU and US templates in divergent directions. Regional arrangements of the new trade powers and Russia could diverge even more markedly, since WTO norms have never fully been internalised by their domestic special-interest groups. This would be a world of “spheres of influence” and bare-knuckle bargaining.
All would lose in this post-tipping point world but not equally. The United States, European Union, Japan, China, and India have enough market leverage to defend their interests. Small nation would suffer much more as they benefit the most from the WTO’s consensus-based rules and negotiations.
Worse yet, moving towards a might-makes-right trade system would be extremely corrosive to global cooperation on the new century’s greatest governance challenges – climate change, pandemics, water scarcity, and the Millennium Development Goals.
What is to be done?
Finishing the Doha Round this year would be a good start. Failing that, leaders must ensure it slips into a quiet coma rather than noisy death throes. But this would not be enough. We must figure out why nations find it so attractive to liberalise outside of the WTO and then change the WTO in ways that restore its central role in trade liberalisation and rule making. The GATT has faced several such historical moments in the past, and GATT members reacted by adopting the necessary reforms. The time has come again for such an effort. Once the old norms are gone, it will be exceedingly difficult to agree to new ones; much better to adapt the WTO’s current norms to address the new century’s realities.
Richard Baldwin is Professor of International Economics at the Graduate Institute in Geneva, CEPR Policy Director and VoxEU.org Editor-in-Chief.]]>
In 2008, Shades of October 1987tag:www.realclearmarkets.com,2008:/articles//5.128422008-07-01T09:14:38Z2008-07-01T14:57:36ZNot long after he took over at the Federal Reserve in 1987, Alan Greenspan was faced with questions about what to do with the Fed funds rate. After polling the various Fed presidents, in September of that year Greenspan found that there was “good growth, high optimism and full employment – all reasons to be leery of inflation.” According to his biography, The Age of Turbulence, the various FOMC members were persuaded “that the Fed would have to raise rates soon.”
In describing the thought processes at work, Greenspan plainly wrote that in order to “subdue inflationary pressures, we were trying to slow the economy by making money more expensive to borrow.” Greenspan’s thinking belies the consensus today suggesting rate increases would aid the dollar. More realistically, the Fed has traditionally hiked rates to reduce dollar demand. From January to mid-October of 1987 the Fed raised it target rate 125 basis points, but the dollar weakened in gold terms from roughly $400/ounce to a high of $481.
tamny
Meet the Press appearance the day before, Treasury Secretary James Baker suggested that the dollar’s fall would not be arrested. The Dow Jones Industrial Average fell 508 points (22.4%) the next day, and as Robert Bartley wrote in The Seven Fat Years, “I think that what the market was saying was that Secretary Baker was toying with the same dollar free-fall Secretary Blumenthal had outlined to President Carter nearly a decade before.” Indeed, with markets fearful of a 1970s inflationary redux, stocks sold off given the negative correlation between inflation and stock/economic performance. The latter in mind, today’s media consensus suggesting Wall Street welcomes cheap and easy money will remain one of those unproven and absurd assumptions.
In response to the crash, Alan Greenspan issued a press release affirming the Fed’s “readiness to serve as a source of liquidity to support the economic and financial system.” Importantly, the subsequent 50-basis point reduction in the Fed funds rate was not a “loosening” of the monetary strings as is so often assumed today. As former Fed Vice Chairman Manuel Johnson wrote with Robert Keleher in Monetary Policy, A Market Price Approach, due to the fall of longer-term Treasury yields on October 19th that shrank the spread between the 10-year and the Fed funds rate, failure on the Fed’s part to reduce its rate would have “constituted a de facto tightening of monetary policy.”
Sure enough, the dollar did not weaken in response to the Fed’s post-crash rate reductions. Far from the monetary “ease” that is frequently used to describe rate reductions today and which presumes devaluation, economist Nathan Lewis noted in Gold: The Once and Future Money that “the dollar wasn’t devalued on Tuesday, October 20, 1987. On the contrary, the dollar went up! After its sickening drop to $481.00/ounce on Monday, the dollar snapped back Tuesday to close London trading at $464.30/ounce.”
Fast forward to today, in some ways there are shades of 1987 in the economic backdrop. China has replaced Japan as the trade miscreant, with anti-China trade legislation ever a threat thanks to a political class eager to be seen doing something for the allegedly down-and-out American worker. And while LBO transactions aren’t threatened by tax changes, those who engage in this kind of activity face the threat of tax increases when it comes to “carried interest” that would reduce the incentives for those in this space to transact at all.
On the monetary front, the dollar has been weakening since 2001 amid varying rate stances from the Federal Reserve. Its fall versus gold began alongside rate cuts, accelerated during 425 basis points of rate increases, and it has continued during the latest round of cuts. Treasury has certainly aided this process in that Secretaries O’Neill and Snow mocked or questioned the importance of a strong dollar, while Secretary Paulson has made plain his desire to see the dollar weaken through his jawboning of China.
And even though the markets have priced in three rate hikes from the Fed beginning in the fall, the dollar has not strengthened as so many assumed it would. Indeed, at $925/ounce gold is once again testing highs experienced earlier in the year. This has occurred amidst a de facto tightening of the kind Johnson referenced judging by a not insubstantial fall in 10-year Treasury yields over the last two weeks.
So while nothing’s ever exact, just as in 1987 we presently have an unseasoned central banker seemingly lost at sea about the true nature of inflation. Much was made of Bernanke’s mention of the dollar a few weeks back, but the main thrust of his “dollar speech” was that rising commodity prices are not a result of monetary mismanagement, but instead a function of too much growth. Like Greenspan in ’87, Bernanke embraces the reprehensible view that growth is inflationary, and that slower growth will reduce commodity prices/inflation.
Bernanke’s lieutenant at the Fed, Donald Kohn seemed to channel his boss in a speech last week. As Bretton Woods Research’s chief economist Paul Hoffmeister wrote in a client report, Kohn’s view is that foreign central banks should seek to weaken their economies in order to fight inflation, or, in Kohn’s own words, in “those countries where strong commodity demands are associated with rapid growth in aggregate demand that outstrips potential supply, actions to contain inflation by restraining aggregate demand would contribute to global price stability."
Adding gasoline to the inflationary and market-enervating fire, Treasury Secretary Paulson continues to dance around the dollar subject. He talks up the importance of a strong unit of account, but refuses to engage in any actions that would signal to the markets he’s serious. With Paulson’s ambiguity in mind, investors should hope against a Sunday talk-show appearance where our Treasury Secretary is quizzed on the dollar’s direction.
Whatever the long-term result of all the above, the S&P 500 fell 3.5% last Thursday and Friday in concert with a 4.5 percent surge in the gold price. Feckless dollar policy from Treasury has joined with impressive economic illiteracy at the Fed in ways that have eroded the dollar’s credibility.
Amidst all this uncertainty there’s a rising consensus among strong-dollar types that the path to nirvana is paved with rate increases. History says this would be a bad idea. Rate increases in 1987 did nothing to shore up the dollar’s value, but did make the economic outlook cloudier alongside a falling unit of account that the Treasury countenanced. All we got out of this market and greenback jawboning was a massive stock-market correction.
Ultimately a strong currency is consistent with low, not high rates of interest. If a strong dollar is what we want, and we desperately need just that, the Treasury need only announce a dollar definition in terms of gold with the Fed’s backing. It could do this without any rate machinations from the Fed, though it should be said that actions taken to define the dollar price of gold lower would over time lead to lower rates across the board.
Just as we did in 1987, we need a stronger dollar in 2008. And as we learned in ’87, we don’t today need rate increases to achieve our dollar-price goals.
]]>
Saving Resources To Save Growthtag:www.realclearmarkets.com,2008:/articles//5.128242008-06-30T18:44:26Z2008-06-30T14:49:51Z
NEW YORK – Reconciling global economic growth, especially in developing countries, with the intensifying constraints on global supplies of energy, food, land, and water is the great question of our time. Commodity prices are soaring worldwide, not only for headline items like food and energy, but for metals, arable land, fresh water, and other crucial inputs to growth, because increased demand is pushing up against limited global supplies. Worldwide economic growth is already slowing under the pressures of $135-per-barrel oil and grain prices that have more than doubled in the past year. Brandon
Jeffrey Sachs is Professor of Economics and Director of the Earth Institute at Columbia University. ]]>
Oil Speculation and Apple Pietag:www.realclearmarkets.com,2008:/articles//5.127902008-06-30T09:29:33Z2008-06-30T03:30:52ZThere have been many accusations about speculators driving up the price of oil. This of course implies that a handful of people can manipulate prices outside of the laws of supply and demand. Perhaps it is also possible that the world is flat and the moon is made of cheese.
A simple analogy can explain why this is incorrect.
Dear Aunt Ethel decides to open a booth at the county fair making her wonderful apple pies. Every pie costs her $2 to make so she sells them for $2.50. Almost immediately, her pies are a hit, and a line grows in front of her booth. Her sister Eileen is running the cash box and suggests to Ethel, who is making and baking the pies, that they raise the price to $3 since the pies are so popular. Ethel agrees and they raise the price. The line continues to grow. They raise the price again to $4, then to $5, yet the line continues to grow and customers are starting to get impatient.
tamny
Eileen, being the better businesswoman, then suggests to Ethel that they sell tickets that promise to deliver a pie later that day. This will shorten the line and limit the number of people standing and waiting for their pies to be finished. The line indeed gets much shorter as Eileen sells the tickets and Ethel feverishly cranks out more and more pies. Ethel and Eileen are making plenty of money and everyone is happy. Well, except bitter Betty at the bratwurst stand who complains to the fair chairman of “excessive profits”.
Now Jacob runs the tilt-a-whirl and notices how many pies Ethel and Eileen are selling. He hears someone say, “Her pies are so good I would pay $10 for another.” Jacob gets an idea to buy the tickets and resell them later, at dinnertime, for a higher price. He’s going to speculate on the price of pies. He heads over to Ethel’s booth and starts buying up pie tickets. A little later, he starts selling them for $7, then $8, and then $10.
Other ride operators notice what Jacob is doing, so they get in on the gig as well, knowing that soon Ethel can’t possibly promise too many more pies. They start buying up the remaining tickets. Of course, Eileen is no fool. She raises the prices to $12, to $15, to $20, and all the way up to $25. The speculators keep buying the tickets, pouring more and more money into the apple pie market at the county fair.
There is a problem here. What will happen if no one wants to buy the pies later for $25? What if no one is willing to pay even $10 for a pie? The pies are coming whether the speculators can sell them or not. People attending the fair have to buy the pies from the speculators or the speculators will be left holding a bunch of pies that nobody wants. Unless the speculators are complete idiots, they know this too. The price can crash, as well as the value of their investment, because they may have paid Ethel to produce way too many pies.
Imagining that ride operators at the county fair are not so wise may not be difficult, but to suggest that Wall Street analysts would be so foolish and not realize that this was possible is a stretch. If they bid up the price of oil much higher than refineries are willing to pay they will likely face catastrophic losses.
Even if they are this foolish, this is good for the consumer in the long run. The price will eventually crash and oil will be cheaper than ever before. When prices are high, oil companies spend more and more money building oil rigs and pipelines, and they will find more and more oil. They are just like Ethel, churning out more and more pies. If the price plummets this new capacity doesn’t go away, because the costs are sunk costs. There will be a huge glut of oil for a long time. If the speculators are really driving up the price of oil, our current pain will soon be alleviated with years of cheap gasoline.
Leave the speculators alone. If they are right, they will make money. If they are wrong, they will lose money. Either way it doesn’t change what we have to pay at the pump. Just because Jacob foolishly bought a pie for $25, doesn’t mean that visitors to the fair will pay $25. Just because Jacob and the speculators paid Ethel to bake 500 pies, doesn’t mean people want to eat 500 pies. When a speculator pays $140 a barrel for oil months in advance, it doesn’t mean that refiners will be willing to pay $140 when that oil arrives. When speculators pay drillers to pump a trillion barrels of oil, it doesn’t mean that we will want a trillion barrels of oil. Supply and demand still rules the retail market.
The Slow Motion Recession Re-visitedtag:www.realclearmarkets.com,2008:/articles//5.127892008-06-28T15:54:32Z2008-06-28T15:57:43Z"We appear to be entering a period of serious stagflation with sharply rising expected and actual inflation combined with large downside risks to growth and employment."
"I would argue that what we are seeing is an acceleration of expected consumer price inflation in the context of a sharp expansion in global liquidity. It is hardly surprising that the prices of those commodities, such as oil, for which the short-run price elasticities of supply and demand are low move upwards strongly when there is a rise in expected general inflation. The oil market is a very convenient vehicle to speculate on expectations of higher levels of general price inflation. Hence my view is that the 40% jump in oil prices that has occurred over the past few months - roughly the period during which financial conditions have been loosened sharply - is a reflection of the expectation of either an acceleration of global inflation, or a depreciation of the US dollar, or some combination of the two."
- Malcolm D Knight, General Manager, Bank for International Settlements
It was only five years ago that the central bankers of the world, and especially the Fed, was worried about deflation. Ben Bernanke was introduced to the world at large with his famous helicopter speech about how the Fed could deal with a deflationary environment. Who would have thought that what passed as humor to a group of economists would be taken so seriously by the rest of the world?David Russell
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Inflation, Deflation and Stagflation
The quote at the beginning of this letter is from the managing director of the Bank of International Settlements, or the central banker to the central bankers of the world. (Thanks to Simon Hunt for the quote.)
Stagflation is a strong word to use, but Knight is surveying a world that is increasingly looking like it is in trouble. A Morgan Stanley study suggests that 50 countries around the globe have inflation running at 10% or more, and that this represents over 3 billion people.
Almost all of those countries have negative real interest rates, or interest rates that are below inflation (as here in the US). Central bankers around the world are slowly raising rates and tapping on the brakes, but they are going to be under increasing pressure to do so. Thus, Knight suggests that global growth is due to slow down even as inflation is rising.
A quick sidebar. I am often asked what I think about the inflation numbers produced by John Williams of Shadow Government Statistics. His number, using the methodology to figure inflation that existed in the late 70s and early 80s suggest that inflation in the US is over 11%. That certainly corresponds to what many of us feel like as we see food and energy prices rise. If you are bearish, a high inflation number makes your case easier.
But let me make a few of you mad. I think what Williams' number actually do is show that the government did not know how to calculate inflation back then. If inflation were actually 11.8%, then that would mean that GDP was a negative 6% today, and that the US would have been in a recession for several years. That is obviously not the case. You can simply look at corporate profits and tax receipts to see the economy has been growing the past five years.
The recovery after 2003 was in fact robust, and corporate earnings were solid, and tax collections went through the roof after the Bush tax cuts. That is not something that would happen in a high inflation environment.
That being said, let me make two observations. Inflation for much of America is much more than the headline CPI of 4%. If you make $40-60,000 for a family of four, the cost of food, gas, medicine, insurance, etc. is causing the inflation you personally experience to be much more than 5%. The CPI reflects the inflation of all items, but your personal inflation rate depends on what you actually buy. And it seems like a lot of the necessities are running well north of 4% inflation.
Secondly, there are some of the statistical methods used to measure inflation which I think are quite suspect, like hedonic measurements. Just because the computer I buy today is twice as powerful as the one I bought three years ago does not mean that the price of a computer dropped in half. I seem to still spend about the same amount on my new computers or cars. It is still the same percentage of my budget.
If we used the same methodology as Europe (for instance), US inflation would be somewhat higher. And that is a number I would find useful for comparison's sake. But let's get back to main thought.
Louis Gave recently wrote a very interesting essay on inflation. He makes the point I have made often, that the Fed is not really increasing the money supply. If you look at the growth in adjusted monetary base, which is the only measure that the Fed actually can control, it has not been all that much over the past four years. But M2 and other measures of money supply have skyrocketed. What gives?
Two things. One is the extraordinary growth in credit offered by banks around the world. We saw a true inflation in financial assets of all types.
Secondly, and this is less intuitive, the US consumer has been a large supplier of money to the world by running a massive trade deficit. We have seen trillions of dollars flow into the world markets which has to find a home. Those dollars have been part of the growth in the supply of dollars around the world.
Now, let me offer a hypothetical series of events which could alter the current environment and maybe even bring back the specter of deflation.
The US trade deficit is roughly where it has been for four years, running in the neighborhood of 6% of GDP. Only a few years ago, less than 30% of that was for oil. Now, that has changed. Roughly 60% of our trade deficit is spent on oil, much of it sadly going to countries that are not necessarily our friends.
The US consumer has cut his spending on non-oil items by almost 40% in terms of GDP over the past few years, and the trend is clearly down every quarter.
Financial assets are clearly deflating. Banks are cutting leverage as aggressively as they once expanded their balance sheets. Even though the data shows that bank assets (lending) are increasing, it is because they are being forced to take assets that have been off the balance sheet and put them on the balance sheet. That trend in the data is going to reverse, and with a vengeance.
We are also watching home values decline, not just here but in the United Kingdom and soon to be so in a lot of Europe, which will put European banks under even more pressure. That is serious wealth deflation.
I have been pounding the table for over a year that financial stocks are going to continue to show losses for at least through the end of this year. Dividends will be cut. More shares will be sold and further dilution will be a fact for many banks both in the US and in Europe. Trying to pick the bottom in the financial stocks is like catching a falling anvil.
And their distress is going to translate into distress for businesses and individuals who need to borrow money. All of this is deflationary. It is a strange world indeed in which we are in the middle of two bubbles bursting and for inflation to be the headline topic of every financial medium.
The source of the inflation is clear. One is rising food costs. World demand for grain is growing at 1.2% a year, yet yield increases are growing at 1.1% a year. The developed world, both the US and Europe, uses a lot of food for bio-fuels. The major areas where we could increase production are areas like Africa where the infrastructure and production methods are poor.
Everyone now believes that food costs are going to go up, energy will continue to rise and the dollar will continue to fall. And maybe all these trends continue. But let me offer a very contrarian thought or two.
Farmers around the world are going to respond to high food prices and by this time next year we could see a rise in supply that more meets the rise in demand. Prices might begin to actually fall.
Energy prices have risen so much that demand destruction is beginning to happen. US drivers are using less gas, and as Asia takes away its subsidies demand will fall as well. You could see oil prices drop over the next year.
And if oil prices drop, that means the US is shipping less of our dollars offshore, which slows the growth of available dollars, raises the price of the dollar which further lowers the cost of commodities.
In a world of decreased leverage, debt and housing deflation, coupled with lower food and energy costs and a higher dollar, it is possible that inflation drops below 2% by this time next year. Maybe more.
Far-fetched? Maybe. But it is a possibility that few are considering. In the inflationary commodity boom of the 70's, there was a 30% correction, which most don't remember. Everyone was convinced that commodity prices could only go one way. And we do not have the wage pressures and inflation that we did in the 70s.
The cure for high prices is high prices. High prices stimulate production and reduce demand. I see no reason that this could not happen again. Over time, I am along term commodity bull. I think oil could indeed go to $200 or more in the next decade, and as a developing world increases its need for commodities of all types, I see growing demand and prices. But that is then long term.
Stagflation on a world wide basis is going to have an effect on demand in the short term. I would be cautious about long only commodity funds. While I do not expect anything to change abruptly, I would be more vigilant and recognize that trends which look so good now can change. I am not suggesting that you get out, just pay attention to supply and demand figures coming out of the developing world.
Five years ago everyone was worried about deflation. A lot can happen in a short time. Ben Bernanke may be dusting off his helicopter speech in a few years, as deflation once again becomes the concern.
The Slow Motion Recession
Last October 5, I wrote a letter called The Slow Motion Recession. The basic premise then and in this space since then has been that we are either in recession or a lengthy period of very slow growth and that this slow growth will continue for some time. The cause of the lackluster growth is the bursting of the two bubbles of the housing market and the credit crisis. These are not problems that can respond quickly to the Fed cutting interest rates, but will need several years to correct. These deflating bubbles will put pressure on consumer spending and thus on corporate profits.
At the end of the day, it is earnings which drive the price of stocks. And if earnings are under pressure, we are going to see the stock market to continue to be under pressure. In a Slow Motion Recession, with growth depressed in the latter half of this year, it is going to be hard for the stock market to gain any real traction. As I have been writing for some time, in a recession the US stock market typically falls 30% or more. We are now down almost 20%. It would not be surprising to see the markets fall another 10%, at least from the perspective of history.
And inflation is not helping. Inflation is often more damaging to stock prices than a slow economy. Inflation, especially in a slow growth economy, eats into profits and can be hard to pass on to customers who are under spending pressure. And while inflation may slowly go away over the next year, it could be a factor for the remainder of the year.
While we should see some rallies in July and August, I think the trend is going to be lower, as the earnings projections are going to come down, and guidance is likely to be soft for many companies.
A Slow Motion Recession, a Muddle Through Economy, and inflationary pressures are not a prescription for a robust bull market. Further giving cause for concern, the recent rise in consumer spending is largely attributable to the stimulus checks being spent. This will be largely over by the middle of the next quarter. As gas and food prices eat into more and more of the average US consumer's ability to spend money on other discretionary items, there will be pressure on almost any company that has exposure to the US consumer.
An Update on Myanmar
My good friend Ed Artis and a team of workers are currently in Myanmar helping the victims of the recent hurricane. His stories are heart- wrenching. My readers have been very generous in helping provide relief. They are one of the few teams that have been able to get in and direct help to exactly where it is needed.
They are working to help re-establish an orphanage, help farmers, supply needed food and medicine to families. The need is overwhelming. He is going to stay a while longer and asked me to ask you, gentle reader, if you could send a donation to help purchase more supplies. The need for food for families is large.
One of the real needs is for more water buffalo. They cost about $500, but allow a farmer to feed his family and more. And it is not as easy buying a buffalo as it looks. Ed tells me that many are in shock. Many of the ones that did not die will not work because they are scared silly. "I never considered that as a possible problem but it is BIG TIME," he writes. "Buffalo with Post Traumatic Stress Disorder just stand there and stare into space."
Donations made thru Pay Pal with a credit card are best as they get quicker access to funds. Go to www.kbi.org and scroll down till you find the donate button. Click on it and it takes you to Pay Pal. "We can also accept checks made out to Knightsbridge International, PO Box 4394, West Hills, CA 91308-4394, they just take longer to get funding to us here in the field."
These are the good guys. They are there on their own nickel. Not a penny goes to overhead or salaries. I cannot say too much about them. I can personally vouch for them. They are a small operation, but their efforts are very large. They get in where other groups just can't. Pony up some money for a buffalo.]]>
Where's Bernanke's Inner Volcker?tag:www.realclearmarkets.com,2008:/articles//5.127602008-06-27T11:03:00Z2008-06-27T11:11:37ZOn the day after an unusually important Fed policy meeting both gold and stocks severely rebuked the central bank's decision to take no action in support of the weak dollar or to curb rapidly growing inflation.
Gold spiked $30, a clear message that Bernanke & Co. won't stop inflation. Stocks plunged over 200 points, an equally clear message that the Fed's cheap-dollar inflation is damaging economic growth.
tamny
These market warnings are two sides of the same coin. Inflation, which is caused by excess dollar creation, is the cruelest tax of all. It is a tax on consumer and family purchasing power. It is a tax on corporate profits. It is a tax on the value of stocks, homes, and other assets.
Crucially, the capital-gains tax — the most important levy on all wealth-creating assets — is un-indexed for inflation. Hence, long before Barack Obama or Congress can legislatively raise the capital-gains tax rate, rising inflation is increasing the effective tax rate on real capital gains. That's an economy-wide problem.
By doing nothing at the June 25 meeting the Fed turned its back on the very inflation-tax problem it helped create. The spanking it received from the markets was well deserved.
Former chairman of the Fed, Paul Volcker, who is advising Senator Obama's presidential campaign, issued a stern warning at the New York Economics Club a few months back. He said inflation is real and the dollar is in crisis. Soon after, Fed head Ben Bernanke changed his tune in public speeches, pledging greater vigilance on inflation and hinting at a defense of the dollar. Treasury man Henry Paulson and President Bush also stepped up their rhetoric regarding a stronger greenback.
But words were no substitute for actions this week.
It is an interesting historical footnote that Paul Volcker still is highly regarded as the greatest inflation fighter of our time. Working with Ronald Reagan, it was Mr. Volcker who slew the inflation dragon in the 1980s. Indeed, the combination of tighter monetary control from the Fed and abundant new tax incentives from Reagan launched an unprecedented 25 year prosperity boom characterized by strong growth and rock-bottom inflation. At the center of the boom was a remarkable 12-fold rise in stock market values, a symbol of the renaissance of American capitalism. But that was then and this is now.
Talk of major new tax hikes is in the air today, while the inflationary decline of the American dollar is plain fact. It's as though our economic memory is being erased, both in tax and monetary terms. Staunchly optimistic supply-siders Arthur Laffer and Steve Moore are even finishing a book on the subject. Called "The Gathering Economic Storm," its concluding chapter is titled: "The Death of Economic Sanity."
The Volcker anti-inflation model presumably handed down to Alan Greenspan and Ben Bernanke always argued that price stability is the cornerstone of economic growth. Yet it appears that today's Fed has reverted to a 1970s-style Phillips-curve mentality that argues for a trade-off between unemployment and inflation, rather than the primacy of price stability.
History teaches us otherwise. It states that since rising inflation corrodes economic growth, inflation and unemployment move together — not inversely. Even in the last 18 months this is proving true. Inflation bottomed around 1% in late 2006. Unemployment bottomed at 4.4% about 6 months later. Today, the CPI inflation rate has climbed to more than 4%, wholesale prices have jumped to 7%, and import prices have spiked to 18%. Unemployment, meanwhile, has moved up to 5.5%.
Over the past five years the greenback has lost 40% of its value. Oil is close to $140 a barrel. And gold, now trading above $900 an ounce, is warning that if the Fed fails to stop creating excess dollars, inflation could rise to 6% or 7%. I had hoped Mr. Bernanke would show his inner Volcker at Wednesday's meeting. He didn't. While the Fed acknowledged that "the upside risks to inflation and inflation expectations have increased," it took no action taken to raise the fed funds target rate, which now stands at 2% and is actually minus-2% adjusted for inflation. Even a quarter-point rate hike — merely taking back the last easing move in April — would have been a shot heard 'round the world in defense of the beleaguered dollar. It didn't happen.
Only Richard Fisher, president of the regional Dallas Fed, dissented in favor of a higher target rate. That leaves the hard-money Fisher as the lone remaining protégé of Paul Volcker.
Of course, if Fed policymakers reconvene immediately to right their wrongheaded mistake, the value of our money could be quickly restored. The next scheduled Open Market meeting is August 5, but they needn't wait that long.
Let's hope they come to their senses.
The Dangers of Central Bank Transparencytag:www.realclearmarkets.com,2008:/articles//5.127022008-06-26T17:16:33Z2008-06-26T17:23:38Z
Central banks are increasingly transparent but is the spotlight stifling? Analysis of FOMC transcripts before and after Committee members knew that they would be published shows how transparency deadened the debate and reduced the number of challenges to Greenspan’s position.Brandon
a trend towards greater transparency in economic policymaking – particularly with respect to monetary policy – and a number of central banks, including Sweden’s Riksbank and Britain’s Bank of England, have adopted a very transparent monetary policy regime known as inflation targeting. The United States does not subscribe to inflation targeting, but the Fed has also become much more transparent about its policymaking and operations over the past 15 years.
Economists have argued that greater transparency is beneficial, improving democratic accountability by making it easier to judge whether a central bank is committed to its announced policy and improving policy effectiveness by facilitating the interpretation of policy changes (see the very accessible review of the discussion by Posen 2002).
But greater transparency of central bank policymaking – in which committee deliberations are made more open to the public – may prevent the full and frank discussion needed to make the best decisions. In a recent paper (Meade and Stasavage 2008), we compare discussions of the Fed’s Federal Open Market Committee (FOMC) before and after committee members knew that all statements would eventually be made public. Our empirical results indicate that after 1993, when FOMC participants knew that their deliberations would be made public, they were less likely to challenge then Fed chairman Alan Greenspan. This suggests that greater transparency hindered free deliberation and may have permitted Greenspan's views on interest rates to dominate US policymaking. In the discussion of the current crisis in credit markets, some have suggested that US interest rates were too low for too long.
Closed doors and open minds
Concern about the effects of open deliberations is not new. Speaking about the secrecy rule that prevailed during the US Constitutional Convention of 1787, James Madison emphasized that full publicity would have made members more reluctant to express their true opinions freely. Madison saw secrecy as having been critical to the Convention’s ultimate success.
Fed policymakers expressed similar concerns when, in 1993, the US Congress pressured them to become more open about their decision-making process. At issue was whether the Fed would agree to publish verbatim transcripts from meetings of its Federal Open Market Committee (FOMC). In Congressional testimony, Alan Greenspan argued against publication, saying that the FOMC “could not function effectively if participants had to be concerned that their half-thought-through, but nonetheless potentially valuable, notions would soon be made public” even with a publication lag of five years. Greenspan noted further that the character of the meetings would change with transcript publication, from lively, useful sessions to bland, sterile ones. In the end, the Fed made the change and subsequently decided to make all of its meeting transcripts available. Transcripts of all FOMC meetings and conference calls from 1978 through 2002 are currently available on the Fed’s web site.
In our paper, we look at whether more information provided by the central bank to the public about monetary policy deliberations can affect the deliberation process itself and ultimately stifle useful debate. We employ a theoretical model in which policymakers care both about making the right policy decision and about how they are viewed by the public. We show that it is possible that policymakers could hold back during deliberations for fear of looking uninformed or incompetent if they know that the content of their discussions will eventually be released to the public. If this happens, then monetary policy might be adversely affected. Thus, the benefits of increased transparency would need to be assessed against the resultant damage to the policy process.
Unique aspect of FOMC transcripts: the tapes that weren’t destroyed
Our research employs a unique aspect of the situation and the transcripts themselves to analyse whether the publication of meeting records has affected the Fed’s deliberations. FOMC meetings have been recorded for more than 30 years so that the Fed staff can write meeting minutes after every meeting. (An account of each FOMC meeting has been published in some form following each meeting since 1936, but these published accounts have been short, non-attributed records of meeting discussion.) Policymakers knew about the recording but thought the tapes were destroyed after the minutes were written. Thus, transcripts exist from a time when policymakers did not know that their deliberations would be made public. We compare deliberations before 1993, when Fed officials believed their remarks were private, with deliberations after 1993, when officials knew that all statements would eventually be made public.
In our empirical analysis, we use a dataset collected from the transcripts themselves that codes verbal messages of each meeting participant and characteristics of the participants, including their name, Fed district, years of experience, and whether they are an official voter at the meeting and, if so, whether the official vote cast agreed with the verbal message sent during discussion. (In the Fed system, votes rotate in a fixed fashion for some policymakers, so that only 12 of the 19 officials vote at any given meeting).
Over the time period that we examine (1989-1997), Chairman Greenspan presented his proposal for the setting of the policy interest rate first and then solicited other meeting participants for their views. After all the participants had expressed their opinions, an official vote was taken on the policy proposal. We focus our analysis on the willingness of the meeting participants to express verbal disagreement with Greenspan’s proposed policy before and after 1993.
The empirical results provide clear evidence of a change in the character of FOMC deliberations – policymakers were less likely to express verbal disagreement with Greenspan’s proposal after 1993. This remains the case even after other potential influences on officials’ views, such as a variety of measures of the current economic environment as well as Fed forecasts for inflation, are taken into account.
We tested the robustness of these empirical results using supplementary hypotheses. First, while the publication of transcripts may have affected FOMC deliberations, it should have had no impact on the votes of policymakers because the votes were published both before and after 1993. We tested the votes in our empirical model and found that votes were unaffected by the release of the transcripts. Moreover, a policymaker should have been less likely to switch his view on the policy proposal between the discussion and the vote – for example, verbally disagreeing with the proposal but voting in favour of it – once the transcripts became public. Our empirical results also accord with this.
Conclusions
Our empirical findings are supported by a number of parallel observations about the changing character of FOMC debate since 1993. While before 1993, FOMC discussions were characterised by frequent “off the cuff” remarks and interruptions, since 1993 there has been an increase in prepared statements that may result in less real deliberation. Our results have significant implications for the design of monetary policy institutions, as well as for the operation of committee-based government decision-making more generally.
References
Meade, Ellen E. and David Stasavage (2008). “The Dangers of Increased Transparency in Monetary Policymaking,” Economic Journal April, 695-717.
Posen (2002). “Six Practical Views of Central Bank Transparency”, http://www.iie.com/publications/papers/posen0502.pdfAuthorsEllen E. Meade is Associate Professor in the Department of Economics at American University. David Stasavage is Associate Professor of Politics at New York University.]]>
Building a Wall Against Talenttag:www.realclearmarkets.com,2008:/articles//5.126842008-06-26T10:51:35Z2008-06-26T10:54:51ZPALO ALTO, Calif. -- Fifty years ago, Jack Kilby, who grew up in Great Bend, Kan., took the electrical engineering knowledge he acquired as an undergraduate at the University of Illinois and as a graduate student at the University of Wisconsin to Dallas, to Texas Instruments, where he helped invent the modern world as we routinely experience and manipulate it. Working with improvised equipment, he created the first electronic circuit in which all the components fit on a single piece of semiconductor material half the size of a paper clip.
On Sept. 12, 1958, he demonstrated this microchip, which was enormous, not micro, by today's standards. Whereas one transistor was put in a silicon chip 50 years ago, today a billion transistors can occupy the same "silicon real estate." In 1982 Kilby was inducted into the National Inventors Hall of Fame, where he is properly honored with the likes of Henry Ford and Thomas Edison.Cari Erickson
If you seek his monument, come to Silicon Valley, an incubator of the semiconductor industry. If you seek (redundant) evidence of the federal government's refusal to do the creative minimum -- to get out of the way of wealth creation -- come here and hear the talk about the perverse national policy of expelling talented people.
Modernity means the multiplication of dependencies on things utterly mysterious to those who are dependent -- things such as semiconductors, which control the functioning of almost everything from cellphones to computers to cars. "The semiconductor," says a wit who manufactures them, "is the OPEC of functionality, except it has no cartel power." Semiconductors are, like oil, indispensable to the functioning of many things that are indispensable. Regarding oil imports, Americans agonize about a dependence they cannot immediately reduce. Yet their nation's policy is the compulsory expulsion or exclusion of talents crucial to the creativity of the semiconductor industry that powers the thriving portion of our bifurcated economy. While much of the economy sputters, exports are surging, and the semiconductor industry is America's second-largest exporter, close behind the auto industry in total exports and the civilian aircraft industry in net exports.
The semiconductor industry's problem is entangled with a subject about which the loquacious presidential candidates are reluctant to talk -- immigration, specifically that of highly educated people. Concerning whom, U.S. policy should be: A nation cannot have too many such people, so send us your PhDs yearning to be free.
Instead, U.S. policy is: As soon as U.S. institutions of higher education have awarded you a PhD, equipping you to add vast value to the economy, get out. Go home. Or to Europe, which is responding to America's folly with "blue cards" to expedite acceptance of the immigrants America is spurning.
Two-thirds of doctoral candidates in science and engineering in U.S. universities are foreign-born. But only 140,000 employment-based green cards are available annually, and 1 million educated professionals are waiting -- often five or more years -- for cards. Congress could quickly add a zero to the number available, thereby boosting the U.S. economy and complicating matters for America's competitors.
Suppose a foreign government had a policy of sending workers to America to be trained in a sophisticated and highly remunerative skill at American taxpayers' expense, and then forced these workers to go home and compete against American companies. That is what we are doing because we are too generic in defining the immigrant pool.
Barack Obama and other Democrats are theatrically indignant about U.S. companies that locate operations outside the country. But one reason Microsoft opened a software development center in Vancouver is that Canadian immigration laws allow Microsoft to recruit skilled people it could not retain under U.S. immigration restrictions. Mr. Change We Can Believe In is not advocating the simple change -- that added zero -- and neither is Mr. Straight Talk.
John McCain's campaign Web site has a spare statement on "immigration reform" that says nothing about increasing America's intake of highly educated immigrants. Obama's site says only: "Where we can bring in more foreign-born workers with the skills our economy needs, we should." "Where we can"? We can now.
Solutions to some problems are complex; removing barriers to educated immigrants is not. It is, however, politically difficult, partly because this reform is being held hostage by factions -- principally the Congressional Hispanic Caucus -- insisting on "comprehensive" immigration reform that satisfies their demands. Unfortunately, on this issue no one is advocating change we can believe in, so America continues to risk losing the value added by foreign-born Jack Kilbys.
georgewill@washpost.com
Trade Embargos Are an Unworkable Mythtag:www.realclearmarkets.com,2008:/articles//5.125562008-06-26T09:36:52Z2008-06-26T11:53:14ZNapoleon “did not realize until it was too late that the only closed political economy is the world economy. Britain could not be starved into submission by blockade unless she were totally cut off from the world. As long as Britain could trade with any nation outside France, it was thus trading indirectly with France.”—Jude Wanniski, The Way The World Works
Seeking to prove that Fidel Castro was still among the living last year, Cuban officials released a photo of the ailing dictator, one in which he was wearing an Adidas track suit. Adidas is a German company, and presently there’s no Germany/Cuba trade embargo as there is between the U.S and Cuba. But had Castro been decked out in Nike (Beaverton, OR) gear, the picture wouldn’t have been any more remarkable.
tamny
Wealth of Nations, “Gold, like every other commodity, is always somewhere or another to be got for its value by those who have that value to give for it.” Even if Portugal had imposed an embargo on England, its gold “would still be sent abroad, and though not carried away by Great Britain, would be carried away by some other nation, which would be glad to sell it again for its price.”
Future events proved the wisdom of Smith’s words. National security issues were raised during England’s Corn Law debates in the 19th century. At that time the debate was about food. The theory among those who supported farm subsidies and tariffs was that if England’s agricultural interests were undercut by free trade, there would not be food to supply the troops or England’s citizens in times of war. Those who defended the Corn Laws forgot that England had been at war in 1810 with nearly every European power, yet still managed to import 1,491,000 quarters of wheat from those same European powers.
In the late 1970s, the United States imposed a grain embargo on the Soviet Union to punish its invasion of Afghanistan. Whether or not this was a good political move, thanks to more open trading relations between the Soviet Union and some of our non-embargoed trading partners, Soviet silos were still filled with U.S. produced grain.
More recently, the U.S. political class blocked a bid by the China National Offshore Oil Corporation (CNOOC) for California-based oil company Unocal. At the time, Reps. Duncan Hunter, Richard Pombo, and forty other congressmen sent the Treasury Department a letter asking for the deal to be reviewed for security concerns, while former CIA director James Woolsey told Forbes that the bid “is a conscious long-term effort to take over... as much of the American economy as possible.” Woolsey’s fear suggesting that Chinese oil demand would detract from our own economic interests gained political traction despite all the history showing its absurdity.
Indeed, whether or not CNOOC owned Unocal was and is largely irrelevant. The Chinese, like us and everyone else, demand oil from what is a world supply. The real reason CNOOC wanted to acquire Unocal was that many of its holdings were near China. Ironically enough, in a recent speech at the Gilder/Forbes Telecosm conference, economist John Rutledge noted that once Chevron’s acquisition of Unocal became official, its own representatives were in China negotiating the local sale of oil pumped from what were formerly Unocal wells!
In modern times, no commodity has been more misunderstood from the trade/embargo perspective than oil. Going back to FDR, every U.S. president has sought alliance with oil-rich Middle Eastern countries based on the discredited fear that, absent good relations, the oil will stop flowing our way.
What’s missed here is that oil is only wealth once it’s sold. Aside from the fact that most U.S. oil imports arrive from Canada, we’ll be the certain recipients of Middle Eastern oil even if every country in that region chooses to place an embargo on us. Once again, no-one controls the ultimate direction of any good once it's been sold.
The above naturally flies in the face of the ever popular and bi-partisan notion of “energy independence.” The latter term is an offshoot of the embargo myth, and is rooted in the false belief that absent an “American” oil supply, we could potentially be cut off from the world’s supply of oil. That this is logically impossible has not kept presidents going back to Richard Nixon from pursuing this false goal.
Whether increased domestic drilling is a good or bad idea, the idea of energy independence is a mirage. Indeed, even if U.S. wells produced every barrel of our domestic needs, our supply and demand would still combine with world supply and demand on the way to a world price. Just as oil producers that don’t like us can’t keep their oil from reaching our shores, neither can we embargo their access to our products in what is a world market. Suffice it to say, given the drastic impact of the dollar’s diminishing value on the price of oil, it seems a bit of a reach to assume that domestic discoveries whatever their size would reduce in any substantial way the price of a barrel.
There’s no accounting for the final destination of goods. Embargos don’t work, but they do make world trade more costly. Nations need to remove the barriers that retard the inevitable process whereby individuals exchange what they deem surplus for the surplus of others.
]]>
Losing Control: The Fed at the Crossroadstag:www.realclearmarkets.com,2008:/articles//5.126132008-06-25T09:22:07Z2008-06-25T03:36:44ZThe June 24-25 meeting of the Federal Open Market Committee will reveal the Fed's attempts to repair the damage from its self inflicted wounds that caused confusion and consternation in the market over exactly what the central banks intends to do about a very real inflation problem.
The last few weeks have not been kind to the market or the Fed. Standing in the heat of a sudden outbreak of hawkish rhetoric, the market quickly priced in up to four rate hikes before the end of the year, sent 30 yr. mortgage rates sharply higher and sent rates on jumbo mortgages up by 70 basis points. The Fed, recognizing the dislocation it had caused in interest rates and rate expectations, walked the market back toward a more reasonable set of expectations. The ten-year and 30 year mortgage rates now stand above where they were in August 2007, before the beginning of the credit crises.
tamny
Besides the laughter you hear from the European Central Bank, the major sound that one hears in the aftermath of all of this is the silent residue of shame at the Fed. To be blunt, the inability to craft and communicate an effective message to convince both the market and public of its intent to deal with the sharp increase in the cost of living has damaged the credibility of the central bank. This utterly avoidable episode begs the question: Is the Fed in the process of losing control of both the market and inflation expectations simultaneously?
It is clear that the Fed did not thoroughly think through the reaction of the market to a sudden and inchoate turn in rhetoric. The embarrassing debasement of its own statements after only a few days did not add one ounce of stability to the markets, did little to regain control of long term rates, and failed to put a real floor under the dollar.
Worse (yes, it gets worse), public expectations of future inflation are in the process of becoming unmoored. The University of Michigan’s survey of consumer confidence has seen its one and five year estimates of inflation expectations increase to 5.1% and 3.4% respectively. Inside the Conference Board’s estimate of consumer sentiment, the public now expects that inflation over the next year will increase by 7.7%. Both surveys provide little relief to a beleaguered Fed.
A look at Fed funds futures suggests that the FOMC will remain on hold until September when traders think that there is a 58.5% chance of a 25 basis point hike. Conversely, the options market remains uncertain about the Fed's next move. The difference in expectations caused by the ineffective and ill-conceived statements out of the Fed can be expected to continue until the FOMC begins to craft an effective communication policy that lays out the rationale for its future conduct of monetary policy. With economic growth in the middle of the year looking much more uncertain than it did when Fed adopted a hawkish tone, the case for a fall hike is becoming more diminished by the day, and with it Fed credibility.
Although the disenchantment of investors with Fed is quite clear, the central bank is not without its supporters. Defenders of the Fed would make the case that the central bank has quite a bit of latitude to wait on inflation to subside. Given the slowdown in economic activity, resource utilization and emerging slack in the economy should provide the sufficient relief to inflation the Fed has been looking for later this year. Most importantly, the Fed still does not believe that inflation expectations are very great.
Indeed, what many consider to be the Fed’s preferred indicator of medium term inflation expectations, the five-year forward, has yet to indicate a crisis. This measure, which attempts to strip out near-term pricing disturbances caused by volatile measures such as energy and food prices, gives the Fed a window into what the market anticipates inflation to be five years hence. This important indicator has yet to push back above 3.0% in 2008 after doing just that at the end of 2007.
Perhaps, but waiting on the economy to illustrate sufficient slack, and for the market to catch up with the inflation expectations of the public at a time of major structural change in demand for commodities and energy at the global level suggests a Fed that is intellectually exhausted.
One only need look at the current pricing environment to ascertain the level of risk entailed by current monetary policy. I expect the consumer price index to breach 5.0% in the upcoming June reading. The Fed’s own preferred measure of inflation, the core PCE deflator, should advance to 2.3%; well above the Fed’s implied target range. And, all things being equal, the PCE core rate one year out should be near 2.7%.
Making matters that much more interesting is that core and headline intermediate costs, as suggested by the recent producer price index, are showing signs of reaching a boiling point. On a three-month annualized average total intermediates are up 27.7% through May. Stripping out volatile factors such as food and energy, they are up 18.5% over that same interval. Thus my own forecast may be underestimating what may actually occur. It is now not a matter of if, but when evidence of higher core rates begins to systematically show up in the data.
Firms are close to reaching a tipping point with respect to the costs of production. At some point corporate and small firms will blink and begin to pass through price increases downstream to customers. When that occurs, indicators such as the five-year forward will move strongly past 3.0% and the Fed may be forced to act well before it is actually are prepared.
Moreover, Mr. Bernanke, whose academic reputation rests on the efficacy of a workable inflation-targeting regime, might find it quite difficult to hold off on increasing rates once a preferred indicator breaches a critical threshold. At that point the Fed Chair would face the difficult choice of sacrificing his credibility. That, or move prematurely to hike rates that could send the economy into a much deeper tailspin than the fundamental data currently suggests is probable. Such are the stakes once inflation expectations begin to careen out of control
Losing control of inflation expectations is a fairly solid working definition of the term “loss of monetary credibility.” A majority of countries that employ the inflation targets that Mr. Bernanke champions now have rates of pricing that exceed their formal targets. Unlike Bank of England President Mervyn King, Mr. Bernanke will be spared the ignominy of an explanatory letter of failure to Parliament. But, if the Fed does not regain control of expectations soon, its credibility will be washed away in a sea of rising prices. If so, it will be years before the market or the public once again trust the Fed.
Pols Remain Masters of Domaintag:www.realclearmarkets.com,2008:/articles//5.126112008-06-25T09:09:19Z2008-06-24T23:27:35ZIn her two great works--The Death and Life of Great American Cities and The Economy of Cities—Jane Jacobs explained that effective economic development and urban renewal arise from the bottom up as the product of thousands of enterprises and people working on their own without a master plan, rather than from the top down, as planned by politicians or bureaucrats. The vibrancy and diversity of city markets and neighborhoods lie in “the creation of incredible numbers of different people and different private organizations, with vastly differing ideas and purposes, planning and contriving outside the formal framework of public action,” she observed.
This week, it is exactly three years since the U.S. Supreme Court’s Kelo decision, which endorsed a very different view of how local economic progress occurs. In that decision, the court said that it was okay for government to condemn and take private property and use it for new economic development if officials believed that the seizures would "provide appreciable benefits to the community, including…new jobs and increased tax revenue." The court’s decision expanded the so-called “takings” clause of the Constitution’s Fifth Amendment, which previously had been interpreted to mean that government could only take private property to create a public “good,” such as construction of a needed new highway or water pipeline.
tamny
The Kelo decision was enormously unpopular, with polls showing that between 80 percent and 90 percent of Americans disagree with the idea, even when property owners received market value for their land. Still, that hasn’t stopped the politicians and urban planners, who moved in quickly. In the first year after Kelo, according to a study by the Castle Coalition, which tracks eminent domain seizures, state and local governments condemned or threatened to condemn more than 5,400 properties, compared to slightly more than 10,000 such actions in the previous five years. In the eminent domain business, a threat to condemn is usually just as good as an actual taking, since a homeowner can’t sell a house under those conditions and a business would find it difficult to do things like get credit.
The homes and businesses targeted in the wake of Kelo ranged from a seafood restaurant in Freeport, Tx., whose property officials wanted so that they could expand a local marina, to a parking lot in Oakland, Ca., which the city wanted to take from a private owner and hand to an auto parts store, to single family waterfront homes in Long Branch, N.J., that the city wanted to see redeveloped into luxury condominiums.
Most Americans object to such takings because the intended uses of the land don’t justify violating property rights when the owner is unwilling to sell to government. But as Jacobs observed, another important objection is that government planners often do a lousy job of anticipating the marketplace when they take property to be developed into something new. What I call mega-project ‘state capitalism,’ the grandiose schemes of politicians and their planners to invest public money in big projects like stadiums, downtown super-malls, and subsidized entertainment districts, has been on the rise for years, often with disastrous results which should have given the Supreme Court justices pause before they gave their blessings to seizures that "provide appreciable benefits to the community."
Indeed, the very redevelopment project that sparked the Kelo lawsuit, an effort by the town of New London, Ct., to turn its Fort Trumbull waterfront into a haven for high-priced homes and 21st century jobs, has sputtered. The ground where Susette Kelo’s home stood is now barren, because the townhouses that the city-sponsored developer was supposed to build there have never gone up. Interest in the area isn’t very great and the developer hasn’t been able to get financing. In fact, what began more than a decade ago as an extravagant ‘public-private’ scheme to redevelop this whole area around tourism, research and development and luxury residential uses has produced little except ongoing construction on a $17 million Coast Guard station.
State capitalism provides more examples of losers than winners. Consider the convention center business. About 25 years ago urban politicians noticed that a few cities, notably Chicago, Las Vegas and Orlando, were cashing in on a booming convention and business meetings marketplace. Almost in tandem around the country, cities rushed to build convention centers or expand their current ones, investing billions in tax subsidized dollars. In some cases, such as facilities in Boston and San Francisco, officials also used eminent domain to take control of private property that stood in the way of the building of their new centers.
The result has been a disaster for the taxpayer. Dozens of new convention properties have opened around the country, creating a glut of convention space, and most centers are underperforming. In 1986 the country boasted 194 centers sporting about 32 million square feet of space, while today there are 322 featuring 66.8 million square feet, with about 40 million more square feet under construction, according to congressional testimony by Professor Heywood Sanders of the University of Texas. The building boom, coming at a time when the convention business has been flat, has turned many of these projects into money-losers. Projections that the new centers would create thousands of jobs to boost the local economy have rarely materialized, leaving taxpayers in Boston, Baltimore, St. Louis and Washington, D.C., among other places, on the hook for additional subsidies.
Public officials and planners continue to pursue such projects in the face of repeated failures in part because redevelopment schemes and ‘public-private partnerships’ help put enormous additional power in the hands of politicians and the private entrepreneurs who partner with them.. In California, for instance, 390 redevelopment agencies operate with the power to condemn property, tax and float debt. Collectively these redevelopment agencies, many run by municipalities and controlled by local politicians, own some $13 billion in property, generate nearly $9 billion a year in revenues (mostly from dedicated taxes) and have racked up some $81 billion in debt—most of it paying tax-free interest thanks to the federal tax code.
Redevelopment authorities and public-private partnerships are especially common in places like California where government has created such a hostile environment for business that officials justify their work as necessary to jumpstart a sluggish economy. But as Doug Kaplan, a California developer, has observed in a piece he wrote for the Castle Coalition, local government would serve their communities better by simply cutting red tape for new development, reducing fees, and focusing on basic government services like public safety, while leaving the rest to the market. Asked by a local redevelopment officer to join a ‘public-private partnership” to open a restaurant in a depressed downtown, Kaplan told him,” If you really want to revitalize downtown, then light the sidewalks, fix the roads, take care of the police, support the schools.” That’s not a message most redevelopment types, or politicians, want to hear, however.
In the wake of public reaction against Kelo, officials in many states promised they would seek laws limiting local use of eminent domain, but although a few states have put in tougher restrictions, in many places there has been little reform because regardless of public sentiment, officials like the power of takings that the Supreme Court gave them. The League of California Cities and the California Redevelopment Association, for instance, undermined efforts by taxpayer groups to pass a referendum restricting eminent domain by putting their own competing, but much weaker referendum on the ballot, one which doesn’t prohibit condemnations against businesses, who are the most common target of seizures.
Today, three years after Kelo, the game of public sponsored economic development subsidized by taxes, tax-free bonds, tax-breaks for favored businesses, and the threat of eminent domain, is alive and well, supporting everything from mega-projects like the massive 22-acre Atlantic Yards in Brooklyn, N.Y., to the efforts by the tiny California town of Hercules to take land away from Wal-Mart because the town fathers objected to the big box retailer invading their domain. Kelo has allowed local officials throughout the country to remain masters of eminent domain, and private markets continue to suffer as a result.
How Can Central Banks Tackle Financial Crises?tag:www.realclearmarkets.com,2008:/articles//5.125912008-06-24T18:00:58Z2008-06-24T17:24:05Z
Central banks cannot achieve price and financial stability with one instrument (interest rates). A counter-cyclical regulatory system is needed to dampen asset booms and to smooth busting bubbles. To use such macro-prudential instruments effectively, regulators need courage, quantitative triggers, and independence; they will be criticised by lenders, borrowers and politicians in both booms and busts.
The events of the last year have reminded us all that a central bank does not just have one responsibility, that of achieving price stability. It is indeed its first core purpose (CP1); but as the sole institution that can create cash, and hence bank reserve balances, a central bank has a responsibility for acting as the lender of last resort and maintaining financial stability. This is its second core purpose (CP2).Brandon
Two goals but only one instrument
One of the major problems of central banking is that the pursuit of these two core purposes can often conflict, not least because the central bank currently appears to have only one instrument, its command over the short-term interest rate. Indeed, a central purpose of the first two great books on central banking, Henry Thornton’s (1802), Inquiry into the Paper Credit of Great Britain, and Walter Bagehot’s (1878), Lombard Street, was to outline ways to resolve such a conflict, especially when an (external) drain of currency threatened maintenance of the gold standard at the same time as an internal drain led to a liquidity panic and contagious bank failures.
Under such circumstances, however, with rising risk aversion, the central bank would find that it had two instruments, due to its ability to expand its own balance sheet, e.g. by last-resort lending, at the same time as keeping interest rates high, (to deter gold outflows and unnecessary (speculative) borrowing). The greater problem, then and now, was how to avoid excessive commercial bank expansion during good times. With widespread confidence, the commercial banks neither want nor need to borrow from the central bank. A potential restraint is via shrinking the central bank’s own balance sheet, open market sales, thereby raising interest rates. But increasing interest rates during good times, (gold reserves rising and high; inflation targets met), i.e. ‘leaning into the wind’, is then against the ‘rules of the game’, and such interest rates adjustments small enough to be consistent with such underlying rules are unlikely to have much effect in dampening down the upswing of a powerful asset price boom-and-bust cycle.
CP1: ‘Price stability’ versus CP2: ‘Financial stability’
Although the terminology has altered, this basic problem has not really changed since the start of central banking in the 19th century. An additional analytical twist was given by Hy Minsky, who realised that the better the central bank succeeded with CP1 (price stability), the more it was likely to imperil CP2 (financial stability). The reason is that the greater stability engendered by a successful CP1 record is likely to reduce risk premia, and thereby asset price volatility, and so support additional leverage and asset price expansion. The three main examples of financial instability that have occurred in industrialised countries in the last century (USA 1929-33, Japan 1999-2005, sub-prime 2007/8) have all taken place following periods of stellar CP1 performance.
We still have not resolved this conundrum. It shows up in several guises. For example, there is a tension between trying to get banks to behave cautiously and conservatively in the upswing of a financial cycle, and being prepared as a central bank to lend against whatever the banks have to offer as collateral during a crisis. Again, the more that a central bank manages to constrain bank expansion during euphoric upswings, e.g. by various forms of capital and liquidity requirements, the greater the disintermediation to less controlled channels. How far does such disintermediation matter, and what parts of the financial system should a central bank be trying to protect? In other words, which intermediaries are ‘systemic’; do we have any clear, ex ante, definition of ‘systemic’, or do we decide, ex post, on a case-by-case basis?
Bank risk and bank-system risk
Perhaps these problems are insoluble; certainly they have not been solved. Indeed, recent developments, notably the adoption of a more risk-sensitive Basel II CAR and the move towards ‘fair value’ or ‘mark-to-market’ accounting, have arguably tilted the regulatory system towards even greater pro-cyclicality. A possible reason for this could be that the regulators have focussed unduly on trying to enhance the risk management of the individual bank and insufficiently on the risk management of the financial system as a whole. The two issues, individual and systemic risk performance, are sometimes consistent, but often not so. For example, following some financial crisis, the safest line for an individual bank will be to cut lending and to hoard liquidity, but if all banks try to do so, especially simultaneously, the result could be devastating.
The bottom line is that central banks have failed to make much, if any, progress with CP2, just at the time when their success with CP1 has been lauded. This is witnessed not only by the events of 2007/8, but also by the whole string of financial crises (a sequence of ‘turmoils’) in recent decades. Now, there are even suggestions that central banks should have greater (even statutory) responsibility for achieving financial stability, (e.g. the Paulson report). But where are the (regulatory) instruments that would enable central banks to constrain excess leverage and ‘irrational euphoria’ in the upswing? Public warnings, e.g. in Financial Stability Reviews, are feeble, bendy reeds. All that central banks have to offer are mechanisms for picking up the pieces after the crash, and the more comprehensively they do so (the Greenspan/Bernanke put), the more the commercial banks will enthusiastically join in the next upswing.
Counter-cyclical instruments
Besides such public warnings, which the industry typically notices and then ignores, the only counter-cyclical instruments recently employed have been the Spanish pre-provisioning measures, and the use of time-varying loan to value (LTV) ratios in a few small countries, e.g. Estonia and Hong Kong. But the Spanish measures have subsequently been prevented by the latest accounting requirements, the IFRS of the IASB; and the recent fluctuations in actual LTVs have been strongly pro-cyclical, with 100+ LTVs in the housing bubble being rapidly withdrawn in the housing bust.
Indeed, any attempt to introduce counter-cyclical variations in LTVs or in capital/liquidity requirements will always run into a number of generic criticisms:
It will disturb the level playing field, and thereby cause disintermediation to less regulated entities (in other segments of the industry, or in other countries). It will thus both be unfair and ineffective.
It will increase the cost of intermediation during the boom and thereby reduce desirable economic expansion (and financial innovation).
It will increase complexity and add to the informational burden.
These criticisms have force. Indeed, there are empirical studies that suggest that countries which allow a less regulated, and more innovative and dynamic, financial system grow faster than their more controlled brethren, despite being more prone to financial (boom/bust) crises. Nevertheless it should be possible to construct a more counter-cyclical, time-varying regulatory system in such a way as to mitigate these problems, so long as the regulations are relaxed in the downturn after having been built up in the boom.
But those same generic criticisms will also mean that regulators/supervisors will be roundly condemned for tightening regulatory conditions in asset prime booms by the combined forces of lenders, borrowers and politicians, the latter tending to regard cyclical bubbles as beneficent trend improvements due to their own improved policies. Regulators/supervisors will need some combination of courage, reliance on quantitative triggers, and independence from government if they are to have the strength of mind and purpose to use potential macro-prudential instruments to dampen financial booms.
Charles A.E. Goodhart is the Norman Sosnow Professor of Banking and Finance at the London School of Economics.]]>
The Recession Debate Misses the Pointtag:www.realclearmarkets.com,2008:/articles//5.125342008-06-24T09:40:15Z2008-06-23T20:24:33ZThe state of the U.S. economy remains a contentious issue among economic commentators. Some argue we are and have been in a recession for some time, while others argue the economy never was contracting and won’t in the future.
When we consider that a lot of the discussion hinges on GDP data points, it could more realistically be argued that the discussion is pointless. That is so given the misleading nature of Gross Domestic Product (GDP) calculations.
tamny
against the law. The Cioffi/Tannin case is a federal one, and it goes hand-in-hand with the Department of Justice’s past destruction of Arthur Anderson which occurred in concert with Congress's passage of the risk-reducing Sarbanes-Oxley. Innovation by definition frequently occurs alongside failure, and with commercial mistakes increasingly the path to jail, it’s fair to ask how much the “tough” stances taken by federal officials when it comes executive mistakes have played a part in what the electorate deems a difficult economic landscape.
Returning to the recession debate, it’s hard to defend Democratic partisans who, with the November elections in mind, seem to delight in the pain wrought by economic uncertainty. When we consider a Democratic platform that consists of increased tax rates, harsh measures against oil companies and more regulation, the Party ought to be careful what it wishes for when it comes to future economic performance on its watch.
On the other hand, GOP partisans ought to be careful defending admittedly bogus GDP numbers that they would eagerly tear into were President Bush a Democrat. Indeed, heading into the 1996 elections it was said by those partial to the GOP that the 2.6 percent GDP growth President Clinton presided over was weak relative to that experienced under Ronald Reagan. While positions taken over 10 years ago were perhaps well founded, 2.6 percent would be a great number today. More realistically it should be said that the IPO market’s disappearance in tandem with a collapsing dollar and a 2 percent rise of the S&P on Bush’s watch is not an economy to defend or write home about.
The numbers used to calculate “recession” or “growth” really only matter insofar as a positive number might save us from another economy-retarding “stimulus” package that would “increase” GDP all the while harming our real economic prospects. Sadly, neither party is talking about the dollar, and with the latter the most problematic economic variable by far, it should be said that whichever party wins in November can expect a short economic honeymoon so long as the greenback is ignored.
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The Return of Inflation?tag:www.realclearmarkets.com,2008:/articles//5.125832008-06-24T09:36:49Z2008-06-24T09:38:36ZForget the housing collapse, the "credit crunch" and -- in isolation -- higher oil prices. The real economic menace may be resurgent inflation, which is the broad rise of most prices. To understand why, some history helps. The government's worst domestic blunder since World War II was the unleashing of high inflation: In 1960, annual inflation was 1.4 percent; by 1979, it was 13.3 percent. This terrified Americans, who feared falling living standards. It also destabilized the economy, causing harsher recessions that culminated with 10.8 percent unemployment in 1982.
We don't want to go there again, and Federal Reserve Chairman Ben Bernanke has been insisting that we won't. In a recent speech, he argued that the economy today is much different from what it was in the mid-1970s. He's right. In 1974, inflation (as measured by the consumer price index) was 12 percent. Unemployment in the parallel recession peaked at 9 percent in early 1975. We're not close to that havoc. Unfortunately, Bernanke's comforting analogy is misleading. The question is not whether it's 1975; it's whether it's 1966.
tamny
It was then that the inflationary psychology -- which later led to so much grief -- took hold. Vietnam War spending and the Fed's easy-money policies created an economic hothouse. Government officials and most academic economists underestimated the danger. Inflation crept from negligible levels to 3.5 percent in 1966 and 6.2 percent in 1969. There are eerie parallels now. From 1997 to 2003, inflation averaged slightly more than 2 percent. Now it's 4 percent; some economists soon expect 5 percent. Hmm.
To be sure, differences abound. Then, we had a classic wage-price spiral. Strong consumer demand allowed businesses to raise prices, which spurred demands for higher wages that companies paid because they needed the workers and could recover the costs through higher prices. In 1959, labor costs rose 4 percent; firms could offset most of that through efficiencies (a.k.a. "productivity"). By 1968, labor costs were up a less-forgiving 8 percent.
By contrast, today there's not yet a wage-price spiral. Inflationary pressures seem to originate mostly in rising raw materials prices. In 2002, oil was $25 a barrel; now it's $135. Corn was $2.30 a bushel; now it exceeds $7. Copper was 70 cents a pound; now it's $3.80. Meanwhile, a powerful anti-inflationary force -- cheaper manufactured imports -- is waning. The weaker dollar and higher transportation costs have raised import prices. In the past year, prices for imported consumer goods (excluding autos) are up 3.6 percent.
We seem to be hostage to global forces. Economists Richard Berner and Joachim Fels of Morgan Stanley call this the "new inflation," because it's not easily squelched by domestic policies. Up to a point, that's true. Although the Fed influences interest rates, it doesn't own oil rigs or cornfields. Long-term price relief for oil involves switching to more-fuel-efficient vehicles and increasing worldwide, including American, oil production. Removing subsidies for corn-based ethanol would reduce food price pressures.
Still, all large inflations involve "too much money chasing too few goods," as economist Milton Friedman often noted, and this episode is no exception. The Fed's easy-money policies have global effects. Many countries peg their currencies to the dollar -- formally or informally -- and shadow Fed policies. Meanwhile, oil producers and other commodity exporters have been flooded with dollars; in practice, the extra cash allows them to run easy-money policies. The result is that despite the U.S. slowdown, much of the world is booming. Developing countries, now about half the global economy, have been growing at about 7 percent since 2002. Higher inflation is a worldwide phenomenon. In China and India, it's about 8 percent. In Russia, it's 15 percent.
One antidote to rising raw materials prices is for the Fed to reverse its easy-money policies. Combating inflation is rarely popular or easy, because it involves slowing the economy -- even inducing a recession -- to relieve pressures on prices and wages. Unemployment rises. There are usually plausible reasons for waiting. Surely there are now. Housing remains in disarray. More loan defaults could increase bank losses. No matter what the Fed does, there are dangers. Perhaps inflation will spontaneously subside (as some Fed officials hope) because the economy is already weak.
But similar arguments for delay were made in the 1960s, with disastrous results. The resulting inflationary psychology made inflation harder to extinguish. The initial unwillingness to take a modest slowdown or recession led to deeper subsequent recessions. There are now signs that we are at a similar juncture. Surveys show that people's "inflationary expectations," after years of stability, are rising. The Fed is holding its key interest rate at 2 percent, well below prevailing inflation. In the 1970s, this condition stoked inflation. An indecisive Fed risks repeating its previous blunder.