Friday, October 15, 2010

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis


Inflation Targeting Proposal an Exercise in Blazing Stupidity; Fed Fools Itself

Posted: 15 Oct 2010 08:43 AM PDT

Lower interest rates are not typically synonymous with rising inflation, but Bernanke foolishly thinks he can get that magic pair with the power of persuasion in conjunction with Quantitative Easing.

Please consider Fed Considers Raising Inflation Expectations to Boost Economy
Federal Reserve policy makers may want Americans to expect inflation to accelerate in the future so they spend more of their money now.

Central bankers, seeking ways to boost flagging growth after lowering interest rates almost to zero and buying $1.7 trillion of securities, are weighing strategies for raising inflation expectations as well as expanding the balance sheet by purchasing Treasuries, according to minutes of the Fed's Sept. 21 meeting released yesterday.

Some Fed officials are concerned that expectations of lower inflation will become self-fulfilling, damping demand by increasing borrowing costs in real terms, the minutes said. By encouraging Americans to believe prices will start rising at a faster pace, the Fed would reduce inflation-adjusted interest rates and stimulate the economy. Chairman Ben S. Bernanke said in 2003 that Japan could beat deflation by using a "publicly announced, gradually rising price-level target."

"The Fed is on the verge of actively targeting a higher inflation rate," said Dan Greenhaus, chief economic strategist at Miller Tabak & Co. in New York. U.S. stocks advanced, sending benchmark indexes to five-month highs, the dollar fell and gold declined for the first time in three days after the minutes were released.

Trying to raise inflation expectations is untested in the U.S. The policy may backfire if actual inflation drifts higher than the Fed would like, potentially eroding gains won in the early 1980s by former Fed Chairman Paul Volcker, who raised interest rates as high as 20 percent to subdue prices.

Jim O'Sullivan, global chief economist at MF Global Ltd. in New York, said in a Bloomberg Television interview that the biggest risk is "boosting long-term inflation expectations more than they lower real interest rates."

The FOMC could adopt a combination of inflation targeting and price-level targeting to get inflation expectations up, said Mark Gertler, a New York University economist and research co-author with Bernanke.

The Fed could restate its commitment to keep inflation rising annually at around 1.7 percent to 2 percent. At the same time, the FOMC could announce some tolerance for inflation above that goal to make up for recent undershooting of those rates, Gertler said.

That would help convince the public that the Fed wasn't going to raise rates rapidly if inflation moved above 2 percent, he said. Such a strategy "tells the market that the farther we undershoot, the more aggressive we are going to be," he said.

Dudley, who serves as FOMC vice chairman and is the only regional Fed president to vote at every meeting, said in an Oct. 1 speech that, for example, "if inflation in 2011 were 0.5 percentage point below the Fed's inflation objective, the Fed might aim to offset this miss by an additional 0.5 percentage- point rise in the price level in future years."

"There's some evidence that inflation expectations are playing a role both in limiting demand and keeping prices low," FTN's Low said.

"You look at housing now and one of the reasons people aren't buying is they expect they can get a better price if they wait," he said. "If that behavior spreads into other markets, it could be a real problem."
Elegant Nonsense

The idea that inflation expectations matter one iota except as pertains to hyperinflation is silly.

Seriously, will you go out and buy appliances, food, autos, gasoline, or anything else just because you expect prices to go up? Even if you would, how much? You cannot store gasoline nor will you buy more food than a freezer or your pantry will hold. Then if you do, then what?

Then if everyone else does too, demand down the road will crash, and prices will fall back as well.

Perhaps you will buy an appliance, but only if you needed one anyway. Then after you buy it, you sure will not buy another.

Thus, it does not take a lot of brainpower to see that at best (a very iffy at best), all targeting inflation expectations can possibly do is shift some marginal demand forward.

However, if stores attempt to take advantage of the Fed's announcement and hike prices, the opposite could happen. With unemployment at 10% higher, higher prices might just as easily scare consumers away as opposed to goading them into spending.

Inflation Targeting is an Exercise in Blazing Stupidity

Stepping back for a second, it is imperative to understand that although the Fed can attempt to increase liquidity, it cannot determine where the liquidity goes, or if it goes anywhere at all.

From that perspective, attempts by the Fed to increase prices, if they worked at all, would more likely than not affect goods with inelastic demand such as food and energy, and commodities via speculation. That is not at all what the Fed wants.

Thus, the entire proposal is an excise in blazing stupidity.

Consumers Need to Deleverage

Consumers are tapped out in need of further deleveraging. Boomers are headed into retirement with insufficient savings. Small businesses are suffering from lack of demand, with rising input costs and lower prices received.

Forcing prices higher now (assuming the Fed could do such a thing) would hurt demand. Yet the Fed is hell bent on trying, first by destructive Quantitative Easing strategies, now with absurd inflation targeting ideas.

Hello Ben, This is Not 2004

This is not 2002-2004 where consumers were willing to mortgage their souls to buy a house. This is 2010 on the back end of housing and credit cycle busts.

The one thing the Fed desperately needs to rise is home prices, but home prices are dead last on the list of things likely to rise should the Fed have any "success" in getting prices to rise.

The last bubble is never reblown. Japan, The dotcom crash, and the housing bubble are prime examples of bubbles not reblown.

After 10 years, only a handful of Nasdaq stocks made it back to new highs. Even solid companies like Cisco and Intel are down 60% or more. After 20 years, the Nikkei is more than 70% off its record high.

Lower Prices Needed

For price hikes to stick, demand must be real, not artificial. Otherwise, forcing prices higher by artificial means such as QE and inflation targeting will just serve to lower demand while increasing speculation and risk in commodities.

Eventually, housing prices and other prices will fall low enough so that genuine demand picks up. When that happens, the economy will stage a recovery.

In the meantime, and just as happened in Japan, the Fed's blazingly stupid policies are actually delaying the recovery.

Fed Fools Itself

I wrote that last night. Caroline Baum had similar thoughts this morning in Fed Wants to Hoodwink Public, Only Fools Itself: Caroline Baum
If I were a central banker, I would be afraid.

If I were a central banker getting ready to embark on another round of quantitative easing, I would be very afraid.

Here's why. Central bankers in the U.S. are being bombarded with market-based signals suggesting their fears of deflation, or falling economy-wide prices, may be misplaced.

Gold prices continue to set new highs. The U.S. dollar, the global reserve currency, keeps sinking amid expectations the Federal Reserve will dilute the existing stock starting at its Nov. 2 to 3 meeting.

Commodity prices, both industrial and agricultural, are on a tear. The CRB Spot Raw Industrial Price Index, which includes scrap metals, cotton and rubber -- but not oil -- hit an all- time high this week.

Junk bond issuance already set a record for the year, with demand for high-yield debt narrowing spreads to Treasuries. Investors are pouring money into emerging markets debt issued in local currencies by countries that used to be considered banana republics. Mexico sold $1 billion of 100-year bonds last week, double the announced issue size, at a yield of 6.1 percent. Just ask yourself: Would you lend money to Mexico for 100 years? Exactly.

If the Fed's goal was to make investors move out the risk curve, it succeeded. An alternate interpretation: Zero-percent interest rates are causing a misallocation of capital, a nice way of saying, "asset bubbles."

Every time policy makers talk about inflation expectations, I want to know just whose expectations they are targeting. The man on the street? The 14.8 million Americans who are unemployed? Small businesses, which are more concerned about the rising cost of health care and taxes than higher prices? Or is it bond traders' expectations, reflected in the price of Treasury securities? The Fed never makes that clear.

These Fed folks and their academic acolytes need to step away from their models and get out in the real world.
Fed Cannot Control Consumer Psychology

The main problem Caroline describes is the Fed can provide liquidity, but not determine where it goes. And as I sated above, that liquidity is going into all the wrong things.

Moreover, record junk bond sales, loans to Mexico, massive demand for emerging market debt do not even factor into the CPI. So while consumer prices stagnate outside of food, energy, and medical, Keynesian and Monetarist clowns call for still more liquidity.

My only disagreement with Baum regards her conclusion: "Policy makers may end up fooling themselves that they can create expectations of a little more inflation without delivering a lot of the real thing. "

The risk is not rising consumer prices, but more credit and asset bubbles just like the housing bubble that popped. We are awash in over capacity with little demand for goods and services. Consumers need to deleverage and so they are. They will continue to deleverage no matter what the Fed says or does.

Models Don't Trump Reality

We are in this mess in the first place because arrogant buffoons at the Fed, Greenspan and Bernanke included, remain in wonderland, where models trump reality.

For more on this line of thinking, please see Drunken Horses and Drunken Horses' Asses in Academic Wonderland
Economic Illiterates Trapped In Academic Wonderland

Only the back end of a horse would think that adding water or alcohol to an ocean of liquidity will solve anything. The fact of the matter is small businesses are the economic driver for jobs, and small businesses will not expand even at 0% interest rates.

For details, please see NFIB Small Business Trends for October Continue to Show No Recovery, Inflation Not a Threat; Fed Governor Hoenig Blasts Bernanke's QE Strategy

It would sure help if the economic illiterates at the Fed would get out in the real world and talk to small business owners.

But they don't and they won't. Instead they sit in their academic wonderland of Monetarist stupidity that says if horses won't drink, give the horses more water and if that does not help, offer them whiskey.

The problem is not falling prices, but falling demand for loans. We are in this mess because of overleveraged consumers, businesses, and financial institutions. Just as you do not cure an alcoholic by offering him another drink, you do not cure a problem caused by excessive liquidity, still more liquidity.
Biggest Bubble Is Fed's Belief In Itself

The Fed could not see asset bubbles form on numerous occasions.

The Bernanke Fed is missing another set of asset bubbles right now in junk bonds, emerging market debt, and arguably commodities.

The Fed believes it is all powerful and can control consumer demand and prices, in a global economy. It can't. We have countless bubbles to prove it. Another set of bubbles is forming now, and the buffoons cannot even see it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List


Retail Sales Rise More Than Forecast; Once Again I Ask "Really?"

Posted: 15 Oct 2010 08:27 AM PDT

Bloomberg reports Retail Sales in U.S. Increased More Than Forecast
Retail sales in the U.S. climbed more than forecast in September, easing concern consumer spending will weaken and endanger the recovery.

Purchases rose 0.6 percent following a 0.7 percent gain in August that was larger than previously estimated, Commerce Department figures showed today in Washington. Other reports showed inflation cooled even further last month and manufacturing in the New York region accelerated.

Retailers like Target Corp. and Wal-Mart Stores Inc. are sweetening discounts and using promotions ahead of the holiday season to move merchandise as joblessness hovers near a 26-year high. Federal Reserve Chairman Ben S. Bernanke today said gains in spending would probably be "uneven" because unemployment was too high, and indicated that additional monetary stimulus may be needed.

"They're reasonably solid consumption numbers," said Jim O'Sullivan, global chief economist at MF Global Ltd in New York. "Momentum is going to be up again in the fourth quarter."
Really?!

Once again I am questioning the numbers. They do not fly in in relation to Gallup Poll Shows Discretionary Spending at All Time Low; Trends Support Double-Dip Theory
Lower- and middle-income Americans' self-reported average daily spending in stores, restaurants, gas stations, and online averaged $48 per day during September -- down $6 from August and $16 from July. Consumer discretionary spending by these Americans making less than $90,000 a year is now at its lowest level since Gallup began daily tracking in January 2008, as the recession was just getting underway.

See above link for more charts.

Retail Sales Not Believable

Calculated Risk has a nice chart in Retail Sales increase in September


Retail sales are up 9.6% from the bottom, but still off 3.2% from the pre-recession peak.

Retail sales had moved mostly moved sideways for six months, but this is now the high for the year.
Retail sales may be at their best point in the year, but sales are certainly not within 3% of the all time high. If they were tax revenue collection would be exceeding all time highs given increases in sales taxes.

Sales Tax Collections Down 5.9% June 2010 vs. June 2008

In spite of numerous sales tax hikes, tax collections are still 5.9% lower than two years ago. Moreover, June of 2008 was not the pre-recession peak. November of 2007 was the pre-recession peak.

Bear in mind those statistics are as reported in Retail Sales Rise .4% from July - How Far to Pre-recession Levels? Where to from Here? reflective of the second quarter.

See link for several charts.

Unless consumers have gone on a tear in the third quarter (highly unlikely with renewed slowdown in housing as well as the recent Gallup survey above), these retail sales reports are simply not believable.

What's clear is the methodology is flawed. By how much is the question. The way to figure out how much is to factor in all sales tax hikes and compare state sales tax collections. I will take another look at that as time permits.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List


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