Mish's Global Economic Trend Analysis |
- Two Year Treasury Yields Drop Below .5% First Time Ever; 30Yr/10Yr Spread Widens Again
- Jobs Decrease by 131,000, Rise by 12,000 Excluding Census; Unemployment Steady at 9.5%; June Revised from -125,000 to -221,000
- Will Quantitative Easing Spur Inflation? Job Creation? Credit Expansion? Do Anything?
| Two Year Treasury Yields Drop Below .5% First Time Ever; 30Yr/10Yr Spread Widens Again Posted: 06 Aug 2010 12:41 PM PDT In the wake of yet another anemic jobs report, Two-Year Treasury Notes Drop to Record Low Yield. Treasuries rallied, pushing two-year note yields below 0.50 percent for the first time, after the government's payrolls report showed the economy lost more jobs in July than economists forecast.Yield Curve as of 2010-08-06 Curve Watchers Anonymous is once again watching the yield curve. Here are a couple of charts.  The above chart shows today's reaction to the monthly jobs report: Jobs Decrease by 131,000, Rise by 12,000 Excluding Census; Unemployment Steady at 9.5%; June Revised from -125,000 to -221,000 The following chart shows the yield curve over time.  click on chart for sharper image The chart depicts weekly closes. 10-year yields did slightly exceed 4% in April but those highs do not show in the above chart. Thus, the decrease in yields is even more dramatic than shown. Note the huge rally on 5 and 10 year treasuries as compared to the 30-year long bond. It appears as if someone is putting on a long-10 short-30 spread. If the economic data continues to be poor (and I believe it will be), the low in 10-year yields may not even be in even if the low in the 30-year long bond is in. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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| Posted: 06 Aug 2010 10:09 AM PDT This morning the BLS reported a decrease of 131,000 jobs. However, that reflects a decrease of 143,000 temporary census workers. Excluding the census effect, government lost 59,000 jobs. Were the trend to continue, this would be a good thing because Firing Public Union Workers Creates Jobs. Unfortunately, politicians and Keynesian clown economists will not see it that way. Indeed there is a $26 billion bill giving money to the states to keep bureaucrats employed. This is unfortunate because we need to shed government jobs. Hidden beneath the surface the BLS Black Box - Birth Death Model added 6,000 jobs. This is one of the saner birth/death revisions in recent months. However, January and July always are. May, June Revisions The change in total nonfarm payroll employment for May was revised from +433,000 to +432,000, and the change for June was revised from -125,000 to -221,000. July 2010 Report
Index of Aggregate Weekly Hours Production and non-supervisory work hours rose .1 to at 33.5 hours and average hourly earnings rose $.02 at $19.02. Birth Death Model Revisions 2009  click on chart for sharper image Birth Death Model Revisions 2010  click on chart for sharper image Birth/Death Model Revisions The BLS Birth/Death Model methodology is so screwed up and there have been so many revisions and up it is pointless to further comment other than to repeat a few general statements. Please note that one cannot subtract or add birth death revisions to the reported totals and get a meaningful answer. One set of numbers is seasonally adjusted the other is not. In the black box the BLS combines the two coming out with a total. The Birth Death numbers influence the overall totals but the math is not as simple as it appears and the effect is nowhere near as big as it might logically appear at first glance. BLS Black Box For those unfamiliar with the birth/death model, monthly jobs adjustments are made by the BLS based on economic assumptions about the birth and death of businesses (not individuals). Birth/Death assumptions are supposedly made according to estimates of where the BLS thinks we are in the economic cycle. Theory is one thing. Practice is clearly another. Household Data Both the number of unemployed persons, at 14.6 million, and the unemployment rate, at 9.5 percent, were unchanged in July.Table A-8 Part Time Status  click on chart for sharper image The key take-away is there are 8,529,00 workers whose hours may rise before those companies start hiring more workers. Table A-15 Table A-15 is where one can find a better approximation of what the unemployment rate really is.  click on chart for sharper image Grim Statistics The official unemployment rate is 9.5%. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6. It reflects how unemployment feels to the average Joe on the street. U-6 is 16.5%. Looking ahead, there is no driver for jobs. Moreover, states are in forced cutback mode on account of shrinking revenues and unfunded pension obligations. Shrinking government jobs and benefits at the state and local level is a much needed adjustment. Those cutbacks will weigh on employment and consumer spending for quite some time. Expect to see structurally high unemployment for years to come. Keep in mind that huge cuts in public sector jobs and benefits at the city, county, and state level are on the way. These are badly needed adjustments. However, economists will not see it that way, nor will the politicians. Recap The private sector hiring increase of 71,000 is very weak for a recovery. That number is not enough to keep the unemployment rate steady. However, the unemployment rate comes from the Household Survey (a phone survey), not from actual payroll data. For a comparison of BLS jobs to ADP (the largest payroll processor in the US), please see... ADP vs. BLS Job Reports - Who to Believe? ADP vs. BLS Tracking Errors - Who to Believe - Update With the revisions in May and especially June, this report was even weaker than it looks on the surface. This economy is sputtering, not recovering, in spite of trillions of dollars of stimulus. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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| Will Quantitative Easing Spur Inflation? Job Creation? Credit Expansion? Do Anything? Posted: 06 Aug 2010 02:11 AM PDT St. Louis Fed James Bullard's proposal to start "quantitative easing" is creating a stir. Chris Ciovacco at Ciovacco Capital Management (and many others) propose the Fed can and will use quantitative easing to induce inflation. I disagree. The following are snips from Chris Ciovacco's article, Reading Between The Lines: James Bullard's Seven Faces of "The Peril" followed by my point-by-point replies. The titles in "bold red" below are questions Chris Ciovacco proposed and answered. My answers are quite different. What could all this mean to me and my investments? Chris Ciovacco: Let's start with quantitative easing, where the Federal Reserve buys Treasury bonds. Using a hypothetical example to illustrate the basic concepts, assume a typical American citizen has some Treasury Bond certificates in a shoebox under their bed. If the Fed offers to buy those bonds, they will be exchanging paper money, not currently in circulation, for a bond certificate. After the transaction, the American citizen has newly printed money and the Fed now has a bond certificate. It is easy to see in this example the Fed has increased the money supply by buying the bonds. The Treasury Bond represents an IOU from the U.S. Government. When the Fed buys bonds in the open market, it is like the government buying back its own IOU with newly created money. This is about as close to pure money printing as it gets. Mish: The typical American citizen does not have Treasury Bond certificates in a shoebox, under their bed, or anywhere else. Those who do have treasury bonds, more than likely have them in a mutual fund portfolio or treasury EFF and they probably do not even realize they have them. The very few who hold treasury bonds outright, are highly unlikely to sell them. How is this policy any different from lowering interest rates or increasing bank reserves? Chris Ciovacco: Lowering interest rates and flooding the banking system with cash has one major drawback; if the banks won't issue loans or customers do not want to take out loans, the low rates and excess bank reserves do little to expand the supply of money in the real economy. Therefore, these policies can fall into the "pushing on a rope" category. Quantitative easing, or Fed purchases of Treasury bonds, injects cash directly into the real economy, which is a significant difference. Mish: Currency in circulation is a factor of demographics, population growth, wage growth, the size of the underground economy, access to credit, and people's willingness to use credit vs. cash. If people do not want to (or can't) hold more money in their wallets, they won't, regardless of what the Fed does. People are not going to hold more cash if they sell their treasury bonds. Of course they are not going to sell their treasury bonds because they do not have them in the first place as noted above. Four Deflationary Reasons People Would Hold More Cash
Those are all deflationary phenomena. However, the main reasons cash in circulation rises over time are population demographics and wage growth. There are more people and the collective sum of cash people keep in their pockets increases as a result. How could all this create inflation and why should I care? Chris Ciovacco: In a simple hypothetical example, assume we could keep the amount of goods and services available in the economy constant for one year. During that year, the Fed buys enough Treasuries to exactly double the dollar bills in circulation. The laws of supply and demand say if we hold supply constant (goods and services) and double demand (dollars chasing those good and services), prices will theoretically double. Obviously, if the prices of all goods and services doubled, the purchasing power of your current dollars in hand would be cut in half. This is known as purchasing power risk. Mish: The Fed can and will supply demand for cash (especially seasonally, think Christmas). However, the Fed cannot control the demand for cash as Ciovacco maintains. Furthermore, Ciovacco is simply mistaken, in theory and practice that increased money in circulation necessarily means prices will rise. Let's look at this in terms of money supply alone. Currency in circulation (as well as money in checking accounts) is dwarfed by M2 and Total Bank Credit. Currency in Circulation  M2  Total Bank Credit  There is $940 Billion dollars in circulation compared to $8,500 Billion of M2 compared to $9,300 or so in total bank credit. If currency in circulation doubled, would prices double all other thing constant? Heck would prices even rise? What prices? CPI - All Urban Consumers  In spite of an unprecedented increase in currency starting mid-recession, the CPI fell. Let's pick another time slot. Since the beginning of 2006 there was a 20% increase in currency in circulation and home prices collapsed as did the stock market. That collapse in asset prices wiped out trillions of dollars of imagined wealth. Thus, sometimes prices rise when currency in circulation goes up, sometimes not. Clearly there are other forces in play. What are those forces? 1. Consumer attitudes towards spending and credit 2. Bank attitudes towards lending 3. Bank capital constraints 4. Businesses willingness to expand If consumers do not want to spend, and businesses do not want to expand, there is not a damn thing the Fed can do about it. Those who think quantitative easing increases prices of goods, services and the stock market should also take a look at Japan's results over the past two decades. If the Fed starts buying bonds what could happen? Chris Ciovacco: Since the Fed would be devaluing the paper currency in circulation, market participants would most likely wish to store their wealth in other assets, such as gold, silver, oil, copper, stocks, real estate, etc. The mere announcement of such a program would begin to accomplish the Fed's objective of creating an expectation of higher future inflation. The expectation of future inflation can lead to asset purchases and investing, which in theory creates inflation by driving the prices of goods, services, and assets higher. In fact, the creation of this document and your reading of it assist in the process of creating increased expectations of future inflation, which is exactly what the Fed is trying to accomplish. Mish: Ciovacco keeps piling error upon error. Except in periods of hyperinflation where there is a complete lack of faith in currency, this whole idea of inflation expectations is potty. People might move demand forward a bit, but they cannot store oil, nor will they buy a computer or more food simply because prices are going up. If you have enough shoes to fill a closet will you buy more? Hells bells, $8,000 tax credits did next to nothing for housing demand? Would $16,000 credits work? By the way, note that those tax credits came from Congress, not the Fed. The Fed has no means to give money away. The Fed can lend, and the Fed can swap good assets for bad with banks, but there is an implied swap back at some point. More importantly, and unlike Congress, the Fed cannot give money to consumers, and consumers are the problem. Thus, the idea that the Fed can increase inflation expectations, and those expectations will result in actual consumer price increases is silly. If that is all it took, they would have done it long ago. By the way, didn't the Fed already try? And Fail? Please see Are we "Trending Towards Deflation" or in It? Also see Bernanke's Deflation Preventing Scorecard Chicken or Egg: Inflation Expectations or Inflation Chris Ciovacco: Mr. Bullard hypothesizes the current economy may need rising inflation expectations to come first, which in turn would help create actual inflation since it would influence the buying and investing habits of both consumers and businesses. If you feel the Fed will "do whatever it takes" to create inflation, you may decide you need to protect yourself from inflation by investing in hard assets, like silver and copper. Your purchases of hard assets would help drive their prices higher. The mere perception of the possible devaluation of a paper currency can change the buying and investing patterns of both consumers and businesses. Mish: For a change, let's assume that Ciovacco is correct. Suppose, the Fed increases inflation expectations and the price of gold, silver, and oil rises. That can happen actually, not necessarily because of "expectations" but as a result of Fed sponsored liquidity seeking a home. However, a rising price of gold or oil is not what the Fed really wants! The Fed is interested in bank credit, lending, and jobs, not the price of gold or commodities per se. The Fed is especially interested in credit expansion because that is what it takes to create jobs. In a fiat-based credit society, a collapse in credit is deflation. Please see Fiat World Mathematical Model for a discussion of money vs. credit in the fiat world. Given that gold has no significant industrial use, the Fed does not care one iota about the price of it. However, the Fed does care about oil and copper. Rising oil prices without an increase in jobs or genuine business activity would certainly add to consumer stress, increase defaults and lead to a further collapse in credit (just as happened in summer of 2008 when oil rose to $140 on speculation alone). This fact that the Fed can print but not dictate where the money goes (or even if it goes anywhere at all) creates an enormous, if not insolvable problem for the Fed. Mish Final Thoughts Because the Fed cannot target money supply other than support housing by purchasing agencies (and that did not work did it?) the Fed might be more reluctant to try quantitative easing than Bullard sounds. Is this the Bullard Bluff? The question is moot because quantitative easing would not accomplish what the Fed wants or what others think it would do except perhaps in some initial fashion that fades away, just as the effect of prohibiting the shorting of financials did. Pushing on a String with 10 Times the Thrust Won't do Much No doubt some will respond that the Fed will keep at quantitative easing until it works. However, pushing on a string with 10 times the thrust won't do much of anything but increase the Fed's exit problem down the road. The Fed already does not know what to do with a trillion dollars worth of Fannie and Freddie assets. What would it do with a trillion more? The Fed is powerless at this point. It has no means of creating jobs. It can offer credit but it cannot force consumers and businesses to take it. The Fed can put money into banks, but it cannot make them lend. Some have argued the Fed can force banks to lend to by charging interest on excessive reserves. I suggest banks would simply take excess reserves and put them in treasuries at 0% in response. Actually if it came to that, the Fed would spook the market with such actions. Think Wall Street would react kindly to forced bank lending? I don't. The stock market would probably collapse. Thus, all of these nice sounding "solutions" that people propose are all flawed. The key to understanding those flaws is fourfold. Keys to the Puzzle 1. Understanding what inflation really is 2. Understanding the role attitudes play in credit expansion and contraction 3. Understanding the what the Fed really is angling to do 4. Understanding the limitations on the Fed What Quantitative Easing Won't Do Careful analysis suggests that quantitative easing is no more likely to spur job creation, bank lending, and consumer spending in the US than it did in Japan (which is to say not at all). It is bank lending, job creation, and consumer spending the Fed is after, not a rise in the CPI or commodity prices. What Quantitative Easing Will Do
No Real Threat of Significant Inflation The real threat of inflation is not the Fed, but Congress. Congress, unlike the Fed, can give money away. However, we will have a new Congress next year, and even this Congress is tired of stimulus efforts. The next Congress is likely to be far more conservative. Congress will give money away of course, but in amounts big enough to matter? The trillions so far did not matter. The reason is credit dwarfs money supply and consumers are struggling to pay down credit. All things considered, odds of significant inflation are seriously overestimated by all but a handful of deflationists who understand the role of credit in a fiat-based credit economy and the Fed's inability to do anything about consumer attitudes towards spending. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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