Enter your email address:
Delivered by FeedBurner
Even as Fed Chairman Ben Bernanke was delivering his long awaited speech Friday on the state of the economy and the potential for further action by the Fed, the Census Department was releasing the latest report on retail sales that showed a healthy increase of 0.6% from August to September. For the three months that make up the third quarter the gains were 0.5% (July), 0.7% (August) and 0.6% (September). The gains in all three months were fairly widespread. If third quarter GDP is not up to snuff, it won’t be because of a lack of consumption. Yet, Chairman Bernanke said in his speech:
In particular, consumer spending has been inhibited by the painfully slow recovery in the labor market, which has restrained growth in wage income and has raised uncertainty about job security and employment prospects.
Looking at a chart of retail sales:
In fact, the year over year change in retail sales is over 7% right now and has been positive every month since November 2009. And it takes no more than an eyeball to see that retail sales are rising at basically the same rate as they have since the beginning of the chart in 1992. Now there are ways to slice and dice this data by removing auto sales or gas station sales but they all basically show the same picture. After the dive associated with the crisis, the US consumer has basically resumed his old ways. And Bernanke expects the pace to pick up next year:
Stronger household finances, a further easing of credit conditions, and pent-up demand for consumer durable goods should all contribute to a somewhat faster pace of household spending.
The other big category that feeds into GDP is investment. Here’s what Bernanke had to say about business spending:
In the business sector, indicators such as new orders and business sentiment suggest that growth in spending on equipment and software has slowed relative to its rapid pace earlier this year.
…….
Although the pace of recovery has slowed in recent months and is likely to continue to be fairly modest in the near term, the preconditions for a pickup in growth next year remain in place.
……
Similarly, business investment in equipment and software should grow at a reasonably rapid pace next year, driven by rising sales, an ongoing need to replace obsolete or worn-out equipment, strong corporate balance sheets, and low financing costs.
And a quick look at a chart shows that orders for non defense capital goods (a good proxy for investment) are rising at a fairly normal rate:
The ISM indexes have shown some recent softening in new orders but they remain solidly above the 50 level that indicates expansion. In addition, the Empire State Manufacturing survey released last week showed a re-acceleration of activity in the NY Fed region. The general index rose from 4.14 in September to 15.73 in October. New orders, employment and shipments all registered sizable gains. The six month outlook also jumped by over 9 points.
We also received several reports on prices last week, none of which showed the alleged economic kryptonite of deflation. Producer prices rose 0.4% month to month and 4% year over year. No deflation here although the rise in business costs might provide a clue as to why companies aren’t hiring or investing at the rate the Chairman, politicians seeking re-election and the general public desires. Unfortunately, the mere expectation of more easing from the Fed is making this situation worse with all manner of commodities spiking in price recently. The Fed might be comforted by the slower rate of rise in the core rate of 1.5% but last I checked, companies didn’t have the option of not paying the monthly energy tab. And if they spend more of their limited capital on higher oil prices, it won’t be there to pay workers or make investments.
Consumer prices also rose last month, albeit a bit slower than the wholesale version. The CPI rose 0.1% from August to September and 1.1% in the last year. Frankly, that sounds like a pretty good performance to me but Ben and his bubble blowing pals on the FOMC apparently think they can do better by which they mean they can make your paycheck disappear more quickly than it already does. Import and export prices also managed to keep rising despite Bernanke’s concerns about the dreaded deflationary dragon, by 3.5% and 5% respectively over the last 12 months. Import prices did fall month to month (-0.3%) but with the dollar doing a swan dive during September that seems highly unlikely to continue.
The purpose of Bernanke’s speech Friday was to lay out the justifications for further policy action by the Federal Reserve. The extent and form of that further action is obviously being debated right now at the Fed and the markets have responded in expectation of what has become known as QE II. But did Bernanke really make a good case for further action Friday? It appears his lament about lagging consumption is off base as retail sales have resumed their previous rate of rise. His own assessment of future business spending is that it is set to rise further next year and the ISM and Fed surveys still indicate current expansion and at least the Empire State survey indicates a recent re-acceleration. Inflation, at least as measured by the CPI is still in positive territory and given the recent rise in commodity prices seems likely to accelerate in coming months. So why does Bernanke and apparently a majority of the FOMC think further action is required?
The decline in underlying inflation importantly reflects the extent to which cost pressures have been restrained by substantial slack in the utilization of productive resources. Notably, the unemployment rate remains fairly close to last fall’s peak and is currently about 5 percentage points above the rates that prevailed just before the onset of the financial crisis.
Ah, so now we find the real reason for Bernanke’s desire for more monetary stimulus. Given his mistaken view that inflation is caused by too many people working, he believes that the high unemployment rate gives him sufficient room to attempt to affect a variable that even he admits is beyond the scope of monetary policy:
Although attaining the long-run sustainable rate of unemployment and achieving the mandate-consistent rate of inflation are both key objectives of monetary policy, the two objectives are somewhat different in nature. Most importantly, whereas monetary policymakers clearly have the ability to determine the inflation rate in the long run, they have little or no control over the longer-run sustainable unemployment rate, which is primarily determined by demographic and structural factors, not by monetary policy.
What Bernanke admits here is that he has no idea what will happen to inflation if the Fed goes ahead and tries to reduce unemployment through the application of further unconventional monetary policy. Even in his flawed way of looking at the economy and inflation, he admits that the unemployment rate at which inflation accelerates is an unknown variable. He and his allies on the FOMC are about to conduct a monetary experiment on the US economy. In fact, although he is apparently unaware of it, the experiment has already started. The steady fall in the dollar over the last month and the rise in stock and commodity prices is a direct result of the mere expectation of his change in policy.
I want to stress that the performance of the US economy remains below its potential. The recent positive developments in various economic reports do not indicate that all is well. Unemployment claims rose again last week and while Bernanke’s view of the economy is flawed on many, many levels he is surely correct in saying that the unemployment rate is higher than anyone desires. The question is whether there is anything monetary policy can do about it without causing even bigger problems down the road. Bernanke obviously believes there is and in fact while almost everyone else on the planet believes the Fed’s excessively easy policy in the early part of last decade was a major contributing factor to the recent crisis, Bernanke described it in his speech Friday as a “watershed” event at the Fed. He obviously feels that the last time they resorted to extreme measures to avoid deflation, the outcome was desirable. I hope I am not the only one who finds that disturbing.
Based on Bernanke’s speech Friday, QE II appears a fait accompli and markets have fully anticipated the arrival of a batch of newly conjured dollars. What markets apparently don’t anticipate is an increase in demand for the new scrip and therefore the value has fallen steadily since Bernanke’s Jackson Hole speech. That is pushing up the price of anything and everything priced in dollars and quite a few things that aren’t. Foreign stock markets continue to outperform their US counterparts with emerging markets doing the best. And the more emerging the better. Easy monetary policy in the US produces effects well beyond our borders as capital flees the falling dollar for better managed currencies and economies. Capital flows where it is treated best and right now that means anywhere but the US.
While QE II may indeed be implemented following the next Fed meeting I can’t but worry that whatever policy change is announced by the Fed will be a disappointment to the market. Bernanke himself has expressed considerable doubt about the effects of any further easing:
However, possible costs must be weighed against the potential benefits of nonconventional policies. One disadvantage of asset purchases relative to conventional monetary policy is that we have much less experience in judging the economic effects of this policy instrument, which makes it challenging to determine the appropriate quantity and pace of purchases and to communicate this policy response to the public. These factors have dictated that the FOMC proceed with some caution in deciding whether to engage in further purchases of longer-term securities.
At this point the market seems to be pricing in a lot of benefit and little cost while assuming an aggressive implementation of QE II. Considering the conservative nature of the Fed as an institution I think that expectation is unrealistic and likely to result in disappointment. Furthermore, I don’t believe the benefits of QE II will be nearly as universal as currently expected. Higher commodity prices, particularly oil prices, were, I think, a major contributing factor to the recent recession. In addition, any “successful” implementation of QE II would seem to involve higher interest rates as the goal is to raise inflation expectations. The bond market started to crack a bit last week and one wonders what will happen when investors who bought bond funds for safety suddenly discover the inverse relationship between bond prices and yields. Caution is warranted.
If you'd like to receive this free weekly commentary by email, click here.
Weekly Chart Review, click here.
Name (required)
Mail (will not be published) (required)
Website
XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>
« Bill Clinton Slips and Tells the Truth Stimulating Asia »
Contrarian Musings is © 2008 Alhambra Investment Partners LLC. All rights reserved. Please read our Terms of Use and Privacy Policy.
Read Full Article »