Tag Archives: Inflation

One small picture says it all

Standing about 2-3 inches tell and 1-2 inches across, a small chart in page A6 of this last weekend’s Wall Street Journal, sums up our economic predicament. The article, Japan Firms End Yearslong Price Freezes, reports that a growing number of businesses are reporting that labor shortages and increasing demand are leading to price increases. The chart shows a pleasing, gradual but clear rise in prices in Japan over the last year, now approaching 1%. This is important.

Though 1% inflation sounds measly for Japan it could be a short-term boon. The nation has been bedeviled for over 20 years with meager growth, stagnant wages, and tepid productivity growth. In fact some economist suggest that Japan’s fall from economic grace that preceded the West’s financial crisis of 2007, demonstrated early what would happen in a deflationary economy with massive quantitative easing. QE did not drive Japan’s economy to growth; it does not seem to have done so in the west, though it may have saved it from crashing and now we see how it’s persistence has led to financial and investment dislocation.

The news all around us is quite positive:

  • Most recent quarterly GDP in US was restated up to 3.3%, almost unimaginable a year ago.
  • EU economic growth rates are forecasted to grow above their recent meager levels in recent OECD reports
  • ‘Currency war’ reports appear in the press infrequently, even though global trade remains torn by the idea that the US wants a stronger negotiating position (for what is, essentially, a very small part of the US economy).

But inflation remains stubbornly low almost everywhere. If Japan soon demonstrates ongoing growth in inflation, and global commodity prices push up, the result will be a wave of input price increase around the world. Some months later the US and more clearly the EU will see producer price increase and so consumers may see pass-through increases. This will encourage central banks to continue their march toward normality.

The downside with a return to inflation: Debt servicing becomes more onerous as interest rates increase in response to inflation increases. As such, governments and businesses that stocked up on cheap debt during QE and the near-zero interest rate period will have to squirrel away more cash to pay their interest charges. This will reduce what’s available for investment, thus slowing down growth.

The cycle feeds on itself so it can sometimes stabilize or other events can kick it into maddening swings. We will just have to see what happens. It may depend on how fast inflation growth returns. But for now, that little picture on page A6 looks very nice in a chilly autumn morning.

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Odds are that US Interest Rates will be back to Zero within 6 months

So it seems the tea leaves in the empty tea cups at the Fed’s recent planning meetings point to the first interest rate hike in 9 years.  The pundits are saying the Fed will raise rates at their regularly scheduled meeting Wednesday this week.  Something like 70-90% of polled economist’s seem to agree.  But hang on a tick – there are a few data points worth calling out:

  • Little has changed globally & economically since September, when the Fed decided against a raise that had been widely expeceted just a month before; Agreed, US economic data in terms of employment has improved slightly and job growth (albeit low wage) is still improving, but…
  • Inflation is stubbonly low (commodity prices globally remain depressed and showing little sign recovering).
  • Wage growth is weak, with only initial signs of a slight uptick recently.
  • The dollar is already quite strong and raising rates will only make it stronger, attracting funds from overseas, thus making US exports more expensive, and imports cheaper (worsening the trade balance).
  • The sucking in of foreign funds to dollars will draw investment from emerging markets that will suffer as a result.  This will further hamper global balancing and growth.
  • The actual business cycle in the US seems to be past its natural peak and business profits are falling in more than half of the economy with firms everywhere reporting contraction.  

On any other day and planet, given these conditions, we would not expect to raise rates.  In fact, in “Central Bankers Worry Rate Increase Will Come Undone” (see today’s US print edition of the Wall Street Journal), it seems that a majority of economists polled for the article worry that the Fed will be forced to undo the increase and return to zero:  “[M]ore than half said it was somewhat or very likely the Fed’s benchmark federal-funds rate would be back to zero within five years”.  Admitedly that’s a long time away and does not hint at panic, and probably allows for the backend of the business cycle to work its way through.  But I think, based on the global situation, the market is too sensitive and volvatile.  

My guess is that though we need to raise rates to move the economy toward normalization, the US cannot move in isolation and without coordinating similar moves in Europe or China.  Since those regions are diverging, the US move will just put more stress on what is already a very stressed system.  Some few weeks ago I was calling for a raise in US rates by the middle of 2016.  I still think that would be the right time to align with other large economic regions, assuming they show signs of recovery – and even that is not firm.  So all told, it will be a fun week.  It is hard to call if the market will rally or fall in response to Wednesday’s meeting.  Maybe the Fed hopes the holiday season will give the marrkets time to adapt and consume the increase and avoid any frantic movements.  Whatever happens I think it will still be a volatile week.  Hang on.

New Data Suggest Western Rate Rise Slips into 2016 – and then some…

After traveling to Asia for nearly two weeks and enjoying the warm and friendly nature of the region, I return to grumpy America where airport staff seem hardly inclined to focus on what a customer means.  Try comparing the welcome from airport staff at Narita (Japan), Changi (Singapore), and Atlanta (USA).  And this is with the same airline!  But beyond the grumpiness in me, due mainly I am sure to the lack of sleep in the last few days, I noted with some depression that several articles and data points, called out in today’s US print edition of the Wall Street Journal, point to a flagging world economy.  Data points to rate rises in the New Year, and even beyond, and less likely in 2015.

Worker Pay Stagnates on Soft Productivity – new data on wage growth and productivity suggest that firms are not yet having to pass pay increases onto employees.  This suggests that though unemployment is now low (5%), the apparent squeeze on employment is not real or widespread.  The lack of wage growth is one of the main factors holding the US Fed back, when it comes to a rate rise.  The lack of productivity is more long term and also effecting the West in general – and portends a deeper concern with the economy.  For without productivity growth, our abilty to pay ourselves more (for a given unit of work/output) will remain flat, or even fall.

Europe Sees Slow Growth – New forecasts for growth in Europe has led ECB leaders to reinforce the likelihood that they will infact increase QE in Europe, this promoting again the “race to the bottom” among competing currencies around the world.  Competitive devaluations by (first) the US, then the ECB, and then Japan, are in a viscious cycle.  The US effectively started the last round when it did not raise rates in September.  The ECB and Bank of Japan have signalled their willingness to increase QE and we are just waiting for them to take action.  This will likely push the US into respond through either delaying the rate rise again, or even adding to QE themselves.  

From today’s US print edition of the Financial Times: UK Central Bank Signals Later Rise in Rates – True to form the data around is attracting central bankers as a lamp attracts moths.  The Bank of England presented new data suggesting lower growth and inflation and this in turn signals a later rate rise.  The following is from the article in

All together now….

Fed Rate Rise – Target now 2016

Headlines in today’s US print edition of the Wall Street Journal are now confirming what a few of us have felt all along: the next move by the US Federal Reserve in moving short term interest rates up, the first such move since 2006, will likely be in 2016, not 2015. I made that call in August (see “Timing is not in the feds favor for a rate rise in September”) – but it is taking time for others to grasp the complexity and dire situation of the global economy. 

The news today in the newspaper is grim:

So the smart money suggests 2016 and at this rate, taking China, commodity prices and other factors into account, middle of 2016 at best.  Only if really strong US wage growth persisted for two periods would the probabilities change significantly.  You have to remember that almost all the dials are glowing “yellow” and turning a darker color towards “red”. Here is my range of expectations based on current economic conditions:

  • Late 2016: 25%
  • Middle 2016: 40% chance
  • Early 2016: 25%
  • By end 2015: 10%

And I also have three bugbears at present.  I hate it when papers report on the how QE has ended.  It has not “ended” – it remains firmly in place.  What has happened is that the Fed has stopped issuing any more.  The billions of dollars the Fed pumped into the economy remains “out there” – if only we knew where all that money it went.  That money has to be brought back; the debt has to be repurchased.  A period of “quantitative tightening” is required in order to get the system back to normality.  A point or two here or there in terms of interest rate hike does not a normal economy make.

Second – Joe Biden should get off the pot.  We all know he will stand – even though his chances dropped after this week’s Democratic Presidential Debate.  Just stand already so we can be entertained and get it over with.

Finally – That fan-favorite of the Tea Party with big budget reform ideas, Paul Ryan, will shortly announce his plan to run for House Speaker, replacing John Boehner.  This was just the opportunity he was waiting for – albeit it coming out of the blue.  Of course he said he would not stand; and of course his supporters pleaded with him.  So please, let’s get that one out the way too.

Rand Paul: The Fed Should Have Raised Rates Already – What’s all the Fuss About?

You have to hand it to Rand Paul, a US senator from Kentucky and a repulican presidential candidate.  While on the world’s stage and under the spotlight, he co-pens an opinion piece in today’s print edition of the Wall Street Journal (See If Only the Fed Would Get Out of the Way) that rings consistent with his father’s past desire to “end the Fed”.  The article is well written and calmly explains why centralized government control of interest rates causes distortions in what otherwise would be a self-correcting system.  The key point made by Mr. Paul and his co-author Mark Spitznagel, chief investment officer at Universa Investments and economic advisor to the Paul campaign, is this: an economy should go through cycles of growth and contraction – but by trying to limit the contraction part and smooth out average growth, or prevent recessions, the Fed creates a false situation that results in cycles that actually exceed the total of the natrual, or smaller cycles.  In other words, we should permit small recessions – by seeking to avoid these we create an economy that is more easily sunk with massive crashed.

The article gives a great analogy with forest fires.  A zero-tolerance policy was adopted bu the US Forest Service 100 years ago – all fires were to be prevented, or put out as fast as possible.  For a while it looked like a good policy.  But in 1988 a forest fire proved unstoppable and it took out 30 times more acreage of any previously recorded fire.  Thus the zero-tolerance policy ended up making the whole system (the forest) a tinder box and so much more fragile.  Thus the Fed drops rates at ever sign of economic trouble in order to stabilize growth, inflation and employment.  It works or seems too, short term.  Long term it creates a much more fragile system that yields much greater and painful busts.  

In 2000 markets started to fall as the dot.com bubble burst.  The Fed dropped rates in order to create a soft landing.  These low interest rates created the foundation for what became our more recent financial crisis triggered from the housing bubble.  So a series of medium sized busts were finally replaced with an unstoppable massive bust.  And here we are.

I have read Ron Paul’s persuasive book, End the Fed.  It is a short book but well written and explains the history of the Fed and gives you more details on the economic model the Federal Reserve system seeks to impress on the economy, but in laymen’s terms.  It is well worth reading.  Mr. Paul’s WSJ article would seem the son has his father’s passion for Fed restraint, though it has not yet come out on stage during any debates.  I wonder if it will this evening?  

For a really interesting understanding of the founding of the Fed, you have to watch this video of G. Edward Griffin: The Quigley Formula.  It is jaw-droppingly good.  And though Mr. Griffin is referred to by some as a conspiracy theorist, the underlaying facts he calls on – such as who attended the meeting (at Jekyll Island) where the Federal Reserve was first conceived, is frightenning.  It beggars belief.  I have since purchased “The Creature of Jekyll Island” but have yet to get to it.  I am looking forward to the debate this evening.

US Fed Rate Hike: Between a Rock and a Hard Place

If you read today’s US print edition you would determine that the US Fed is in a right pickle.  Domestic data would suggest the US economy is making progress and there are arguments for raising rates.  However international data suggests there is great risk.  Even in the last 24 hours, we have seen the World Bank suggest raising rates will damage emerging market (EM) growth significantly; today’s paper includes reports from Asia where EM central bankers are calling for the rate rise.  What to do?

The Comment piece by Richard Fisher, former president of the Federal Reserve Bank of Dallas, is apersuasive  narrative (see Monetary policy operates with a time lag so the Fed must act soon) on the real underlaying inflation “gap”that has plagued public and official reporting of that troublesome data point.  Low and persistently low inflation is one of the key measures the US Fed has said would hold back a rate rise.  The other troublesome indicator is wage growth.  But Fisher suggests that there are more modern models for inflation that show the real rate is closer to the 2% the US Fed is looking for.  I myself have blogged in the past (see US Inflation analytic is out of data.  So Let’s Update it Then!) that real inflation, what consumers see in the shops and at home, has been creeping up all along.

However in Emerging Markets Braced for Rippler Effect, Mohamed El-Erian, chief economic advisor to Allianz, pointed out the connected nature of our global economy.  As US interest rates rise, so investing in the US will look more attractive than, say, investing in China.  At the margins capital will shift from China to the US.  Only last week China had to use some of its vast FX and US treasury reserve to defend the yuan. Should capital flow from China, the value of its currency will fall, and so the Chinese authorities may need to defend the yaun again.  If China continued selling some of its US treasuries, this could create a glut of debt instruments on offer by the US.  To help encourage the picking up of that glut, the US will be pressured to increase rates further.  Thus this very first small rate rise that the US Fed is contemplating has to be right; and it could create a domino effect that will be hard to stop.  

So all in all the data provides mixed messages, both domestically as well as internationally.  And worse, the actual delay itself as to when the rates will actually rise is adding to market volatility.  As I said the other day, the US Fed is dammned if they don’t increase rates, and dammned if they do.  The problem is, not knowing which damnation awaits, is itself a horrible situation to be in.  Oh to be paid the big bucks and lead the Federal Reserve.

The World is in an Economic Funk and Shows No Sign of Change

The global economy is in deep trouble.  

Forget the headlines reporting meager growth in the U.S. Forget the positive news about German exports. Ignore the stories that China’s worries are overblown (see The Economist leader, The Great Fall of China). Our global economy is like a tired old boxer on the ropes, with blow after blow raining down on him. There are just too many signs that suggest we are running on empty and, with little in the tank, we are about to fall- heavily.

Let’s first look at the U.S. The Fed is toying with the first interest rate hike since 2007. Many hedge fund operators have never even seen a rate hike before. With volatility so vibrant, in the stock market and the price of oil among others, there is no way the Fed will increase rates. Or will they, to save face, nominally increase rates by the smallest amount possible? And what would the impact be anyway? If purely symbolic, it will only signal a future for the Fed that will surely come as the yuan fulfills its destiny as reserve currency.

Global trade is in the can. Data from the Dutch World Trade Monitor suggests that “world trade contracted in the first half of the year at the fastest pace since 2009”. See The Economist The World This Week. With China’s growth slowing, Euro-zone anemia, and U.S. negligence, is it going to get better? No.

See “Emerging market currency wars threaten to cut back world trade” in the U.S. print edition of the Financial Times.  The financial times today (US print edition) carries a troubling analysis of emerging market currency impact on global trade. It seems that their analysis suggests that over 100 currencies that have devalued (or tried to) against each other and rather than act as a boost for imports, it damages exports. This is not logical since lower currency exchange should drop the prices of exports. Clearly something else is happening.

Why this is troubling is that this kind of behavior is very typical in history as a response to periods resulting in really difficult economic conditions. The period between the two World Wars were subject to dangerous and frightening currency valuation changes. The U.S. embarked on a globally damaging deflationary period in the early 1920’s, just as Europe, looking for stability to drive recovery, were looking to rejoin the gold standard to stabilize currency exchange. The U.S. action prevented this. And competitive currency devaluations became the norm and global trade struggled and so too economic recovery.

Some specific data is alarming:  

  • low wage growth in U.S. for what appears to be a healthy job recovery
  • near zero or zero interest rates and high public debt suggesting little wiggle room for many western central banks, when or should recession hit
  • commodity prices at extremely low levels, in some cases the lowest this century
  • inflation stubbornly low or falling
  • anaemic economic growth in the west, and falling growth in the east

The commodity price issue is alarming because of the pent up price deflation in the supply chain. The Economist article reports that factory-gate pricing continues to fall across Asia. “In China they have declined for 41 consecutive months; in South Korea and Taiwan for 35 months; and in Singapore for 31 months”. Prices in consumer and industrial product supply chains will fall, not increase. Deflationary pressures continue to build.

But it is not any one currency depreciation, or any one interest rate, or any one measure of GDP, that is proving our most important challenge. Did you notice how last week the market movements around the world, among the largest in history, were not triggered from anything the U.S. reported or Federal Reserve said. The source was China; the stabilizing function emerged from China (reduced interest rates). I was taken aback at the market dynamism and the role of China as villain and then hero, in the space of a week. 

What is killing and preventing progress is not the data, but the changes in the data. Or more precisely, it is the volatility with which policy, data and results are changing. This week the price of oil oscillated more than it has since 1977. It is the nervous features of a complex system that is preventing progress. It is September 1st and the next Fed meeting is but 15 days away. Pundits flip flop, daily, with their “go/no go” rate change advice for the Fed. This is crazy. How can such an important policy decision be so vague and varied but two weeks away? How in the world can the Fed get this right? They have as much chance as a crap shoot at a circus. Really.  

Sure, unemployment has recovered well. But for the fact that job recovery has not driven high paying jobs: wage growth is nonexistent. Policy types talk of increased minimum wage, rather than economic growth, as if money grows on trees. Productivity in the developed world has all but stalled. No one seems to care as they would rather spend time counting out the welfare services they want to increase. Student debt in the U.S. is out of control. So instead of reducing grants that would reduce a universities ability to charge higher fees, we hear arguments for increased government contributions and debt forgiveness. Really? This is all madness. Out leaders have lost the plot. Worse than that we have, as individual countries, almost lost the ability to advantage oneself over others.  

The Economist article, “Briefing: China and the World Economy- Taking a Tumble” suggests that the gyrations of the Chinese stock market, when it jumped up, and crashed down, do not reflect changes in Chinese economic conditions. There are technical points made in the article that show this. But the way in which the stock market signals trigger painful and volatile changes around the world are worrying. If the Chinese stock market did not matter much, why the dramatic changes in Europe and U.S.?

I wrote an Open Letter to Christine Lagarde, head of the IMF,  the other day. If ever we needed another meeting of minds, such as a Bretton Woods level, it is now. We need to coordinate macroeconomic policy in order to 

  • stabilize currency value and therefore exchange
  • agree where and how to prevent barriers to global trade increasing and infect reduce them
  • agree policy to coordinated investments at a national level that drive short to medium term growth
  • agree policy to reduce public sector debt

We are so over the edge it’s not funny. No policy, no headline, no movement, not even any one change of office, will fix this funk. Coordinated, visionary leadership is needed. Where is the Keynes and the Harry White we need?

The jobs report is due September 4th. If the news is good, the Fed may increase rates despite the market, the global, volatility I speak of. I think that would be a mistake. We don’t need to focus on when the Fed will raise interest rates. We need to focus on collaborating, alignment, and reduction of volatility.