| Historical Perspective on CPI Deflations: How Damaging are They? Posted: 30 Mar 2015 08:39 PM PDT Yet another central bank has announced a warning about the perils of deflation. Please consider China Central Bank Calls for Vigilance on Deflation. China's central bank governor Zhou Xiaochuan warned on Sunday that the country needs to be vigilant for signs of deflation and said policymakers were closely watching slowing global economic growth and declining commodity prices.
Zhou's comments are likely to add to concerns that China is in danger of slipping into deflation and underline increasing nervousness among policymakers as the economy continues to lose momentum despite a raft of stimulus measures.
"Inflation in China is also declining. We need to have vigilance if this can go further to reach some sort of deflation or not," Zhou said at a high-level forum in Boao, on the southern Chinese island of Hainan.
Zhou added that the speed with which inflation was slowing was a "little too quick", though this was part of China's ongoing market readjustment and reforms. Historical Perspective On CPI DeflationsIn its March report, the BIS took a look at the Costs of Deflations: A Historical Perspective. Here are the key findings. Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link bet ween output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt.
Deflation may actually boost output. Lower prices increase real incomes and wealth. And
they may also make export goods more competitive.
Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.
Conclusions
The evidence from our long historical data set sheds new light on the costs of deflations. It raises questions about the prevailing view that goods and services price deflations, even if persistent, are always pernicious. It suggests that asset price deflations, and particularly house price deflations in the postwar era, have been more damaging. And it cautions against presuming that the interaction between debt and goods and services price deflation , as opposed to debt's interaction with property price deflations, has played a significant role in past episodes of economic weakness. The exception to the general rule was the Great Depression but, that was also an asset bubble deflation coupled with consumer price deflation. Meanwhile central banks on every continent are worried about something they should welcome. Economic Challenge to KeynesiansOf all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them. I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples. My January 20, post Deflation Bonanza! (And the Fool's Mission to Stop It) has a good synopsis. And my Challenge to Keynesians "Prove Rising Prices Provide an Overall Economic Benefit" has gone unanswered. There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced. Worse yet, in their attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear - asset bubble deflations following a buildup a bank credit on inflated assets. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Indiana Legalizes Discrimination on Grounds of "Religious Freedom" Posted: 30 Mar 2015 05:36 PM PDT Can you refuse service to gays and lesbians? You can in Indiana thanks to the "Religious Freedom" Bill. Indiana Governor Mike Pence has signed a bill that would allow businesses to refuse service to gay and lesbian patrons on the grounds of "religious freedom", even as some of the state's largest business interests oppose the measure.
Mr Pence, a potential 2016 presidential contender, said he signed the bill because "many people of faith feel their religious liberty is under attack by government action". Proving that he cannot think, Pence quipped " If I thought it legalised discrimination in any way in Indiana, I would have vetoed it." And what about religious freedom for atheists, Muslims, ISIS? Can they do whatever they want too, or is this just religious freedom for Christians and Jews?  Where does one draw the line? Can I post a sign Catholics not welcome? Jews go home? Greg Ballard, the Republican mayor of Indianapolis, has said that the Indiana law sends the "wrong signal". "Indianapolis strives to be a welcoming place that attracts businesses, conventions, visitors and residents," he said in a statement Wednesday.
In recent days, three major conventions have threatened to pull out of the state because of the bill. The organisers of Gen Con, the city's largest convention, said the law "will have a direct negative impact on the state's economy, and will factor into our decision-making on hosting the convention in the state of Indiana in future years". History Lesson for PenceThe opening of the United States Declaration of Independence states as follows: We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the Pursuit of Happiness. That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed; " Many people of faith feel their religious liberty is under attack by government action," said Pence. Actually, people of all races, creeds, and religions are under attack by this ludicrous bill. BacklashBacklash is mounting. The Guardian reports Indiana Republicans to amend 'religious freedom' law in face of backlash. The next day, the social media campaign #BoycottIndiana took over Twitter, and on Saturday hundreds gathered at the statehouse in Indianapolis to rally against the bill.
By Monday night, protesters were gathering again, this time in front of the Indianapolis City-County building. Protesters recited the pledge of allegiance, shouting the "for all" at the end of the oath.
Local businesses across the state capital have posted signs bearing the message that Indiana citizens, known as Hoosiers, will "not serve hate".
The band Wilco canceled a performance in Indiana in protest to the law, and major Indiana-based businesses such as Angie's List have put expansion plans on hold and other companies, like Salesforce.com, have stopped sending employees there for business.
"This is not just a gay issue, this is a Hoosier issue," said city councilman Zach Adamson, the first openly gay elected councilman in Indianapolis. "We are, as a people, incensed about it."
On Sunday, Pence defended the bill in an interview with George Stephanopoulos on ABC's The Week.
The appearance inflamed opponents as Pence danced around questions about the law's discriminatory implications and refused to directly answer questions about whether it gives businesses the right to deny service to LGBT people – six times.
"This is not about discrimination, this is about empowering people to confront government overreach," he said. Asked again, he said: "Look, the issue here is still: is tolerance a two-way street, or not? … We're not going to change the law." Message of Inclusion?!State legislators say law is not anti-gay and blame the reaction on a ' mischaracterisation'. ' What we had hoped for was a message of inclusion'. This has nothing to do with " inclusion". This has everything to do with a hopeless candidate foolishly appealing to the ultraright extremists and it backfired big time. To Pence, you are equal unless your religion says otherwise. He is exactly the kind of fake-conservative jackass the Republican party needs to get rid of. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Ben Bernanke, Confused as Ever, Starts His Own Blog to Prove It Posted: 30 Mar 2015 01:09 PM PDT Ben Bernanke just started his own blog at the Brookings Institute. His first post, from today, Inaugurating a New Blog is the announcement. Let's dive into Bernanke's second post of the day: Why are Interest Rates So Low? Bernanke: Low interest rates are not a short-term aberration, but part of a long-term trend. As the figure below shows, ten-year government bond yields in the United States were relatively low in the 1960s, rose to a peak above 15 percent in 1981, and have been declining ever since. That pattern is partly explained by the rise and fall of inflation, also shown in the figure. Mish: Inflation is only low if one ignores asset bubbles. The CPI does not factor in bubbles induced by monetary policy. The Bernanake and Greenspan Fed ignored the biggest bubble ever in housing for which the Fed has never apologized nor admitted any wrong doing. The effects of inflation are visible everywhere, except of course where the Fed looks. Bernanke: If you asked the person in the street, "Why are interest rates so low?", he or she would likely answer that the Fed is keeping them low. That's true only in a very narrow sense. But what matters most for the economy is the real, or inflation-adjusted, interest rate (the market, or nominal, interest rate minus the inflation rate). The real interest rate is most relevant for capital investment decisions, for example. The Fed's ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed. Mish: It is difficult to say precisely where interest rates would be in the absence of the Fed, but the answer is likely, surprisingly low. The reason is the Fed (central banks in general) coupled with government deficit spending and fractional reserve lending are the very source of inflation. Amusingly, the Fed bills itself as an "inflation fighting force" but it is a key determinant of inflation. Worse yet, and since the Fed is totally clueless about asset bubbles, it fails to see inflation in front of its nose. Bernanke: To understand why [the Fed's ability to affect real rates is transitory and limited], it helps to introduce the concept of the equilibrium real interest rate (sometimes called the Wicksellian interest rate, after the late-nineteenth- and early twentieth-century Swedish economist Knut Wicksell). The equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment. Many factors affect the equilibrium rate, which can and does change over time. If the Fed wants to see full employment of capital and labor resources (which, of course, it does), then its task amounts to using its influence over market interest rates to push those rates toward levels consistent with the equilibrium rate, or—more realistically—its best estimate of the equilibrium rate, which is not directly observable. Mish: With that, the Fed admitted it is clueless about the alleged "equilibrium rate". Indeed it is not observable, nor is the concept of full employment known or observable. Government interference in the free markets, especially minimum wage laws grossly distort the level of full employment. Factor in changing consumer preferences and demographics, and it's a fool's mission to believe the Fed (any central bank), can come up with a realistic estimate to something Bernanke correctly admits is not directly observable. Bernanke: When I was chairman, more than one legislator accused me and my colleagues on the Fed's policy-setting Federal Open Market Committee of "throwing seniors under the bus" (to use the words of one senator) by keeping interest rates low. The legislators were concerned about retirees living off their savings and able to obtain only very low rates of return on those savings. I was concerned about those seniors as well. But if the goal was for retirees to enjoy sustainably higher real returns, then the Fed's raising interest rates prematurely would have been exactly the wrong thing to do. Mish: It's not the interest rate policy directly that threw seniors under the bus. Rather, it's the Fed's inflation policy while ignoring the consequences of asset bubbles that threw everyone but those with first access to money under the bus. The Fed ignored an enormous housing bubble (Bernanke did not see it at all), then when housing crashed, the Fed lowered rates to save the banks. The overall action was as "necessary" as it was to have a Fed sponsored housing bubble in the first place. Bernanke: A similarly confused criticism often heard is that the Fed is somehow distorting financial markets and investment decisions by keeping interest rates "artificially low." Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by "the markets." The Fed's actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere. Mish: Bernanke's comment is preposterous. There was not always a Fed. And the market once set interest rates on its own accord. Moreover, there does not need to be a Fed any more than we need government central planners to determine steel production or the price of orange juice. The Fed certainly does have a choice. Bernanke: So where should that be? The best strategy for the Fed I can think of is to set rates at a level consistent with the healthy operation of the economy over the medium term, that is, at the (today, low) equilibrium rate. There is absolutely nothing artificial about that! Mish: It's as artificial as the Fed determining how much steel the mills should produce! In other words it's totally artificial. Besides, Bernanke even admitted the Fed does not know what the equilibrium rate is, and it ignores asset bubble when attempting to land on the unknowable and unobservable. Is it any wonder the Fed has blown asset bubble after asset bubble with increasing amplitude over time? OER vs Home PricesI have made several posts on the consequences of ignoring asset prices while attempting to measure "inflation. Here are two charts from my September 2014 post Housing Prices, "Real" Interest Rates, and the "Real" CPI. In the following charts and commentary, I substitute actual home prices as measured by the Home Price Index (HPI), for Owners' Equivalent Rent (OER), in the CPI. Comparative Growth in HPI vs. OER
From 1994 until 1999 there was little difference in the rate of change of rent vs. housing prices. That changed in 2000 with the dot.com crash and accelerated when Greenspan started cutting rates.
The bubble is clearly visible but neither the Greenspan nor the Bernanke Fed spotted it. The Fed was more concerned with rents as a measure of inflation rather than speculative housing prices.
Two Inflation Indexes Year-over-Year
The above chart shows the effect when housing prices replace OER in the CPI. In mid-2004, the CPI was 3.27%, the HPI-CPI was 5.93% and the Fed Funds Rate was a mere 1%. By my preferred measure of price inflation, real interest rates were -4.93%. Speculation in the housing bubble was rampant.
In mid-2008 when everyone was concerned about "inflation" because oil prices had soared over $140, I suggested record low interest rates across the entire yield curve. At that time the CPI was close to 6% but the HPI-CPI was close to 0% (and plunging fast). I would specifically like to see Ben Bernanke comment on those charts and how and why he thinks asset bubbles can be excluded from measures of inflation. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| Wishful Thinking: "Strong Growth" to Propel Housing Posted: 30 Mar 2015 12:06 PM PDT CoreLogic chief economist Dr. Frank Nothaft says Strong Economic Growth To Propel US Housing Market in 2015. The U.S. economy is poised to grow by close to 3 percent in 2015, generating a 3- to 3.5-million-person gain in employment. This job growth, coupled with very low mortgage interest rates and some easing in credit access, is expected to propel both owner-occupant and rental housing activity this year. This heightened level of housing demand should translate to the best home sales market in eight years, a projected rise of about 5-6 percent in the national CoreLogic Home Price Index (HPI) and mortgage originations that will likely rise in 2015 compared to last year.
Economic growth near 3 percent
U.S. economic growth will be buoyed by three forces in 2015. One is the halving of energy prices since last summer, with prices unlikely to jump back up this year. This price drop has the similar beneficial effect on aggregate economic performance that a tax cut would have: Both consumers and business owners have more cash left each month to spend on other goods or invest in new equipment and financial assets. Lower energy prices could boost growth by as much as 0.5 percent, even though regions of the U.S. with jobs tied to energy production will face a slowdown.
A second force at work is the rise in consumer and business manager confidence in the economic recovery. This rise has been pronounced over the past year, coinciding with the pickup in economic growth (better than 4 percent annualized growth over the last three quarters of 2014) and the drop in energy costs. The Conference Board Consumer Confidence Index and the National Federation of Independent Business' Small Business Optimism Index have both risen to the highest levels since before the Great Recession. Consumers who feel more financially secure are more likely to form new households and more likely to transition from rental to ownership; and businesses that are more optimistic that demand will be there for their products are more likely to hire staff.
The third factor at work is a significant improvement in the budget outlook for state and local governments. With tax receipts stronger than expected, state and local governments will likely spend more, providing further stimulus to aggregate demand. With these three forces working in concert, 2015 economic growth could hit 3 percent, making this year only the second calendar year over the past decade with growth of 3 percent or better. Head in the SandNothaft has his head in the sand. He ignores a massive string of bad economic reports, while focusing on the lagging influence of jobs. Having followed confidence numbers for years, the numbers are volatile and pretty much useless.  Where are confidence numbers going from here? I actually suggest down because I expect a recession based on firmer data. Manufacturing Business Confidence There are all kinds of confidence indicators but how people feel at the moment is fleeting, and how confident they feel in six months is typically useless. Small Business Optimism Is NFIB confidence poised to soar, plunge, or go nowhere? The latest month was a dip. Although the index is back at pre-recession levels, is the level in 2007 much of anything to brag about? Global EconomyChina is slowing along with the global economy. The dollar has hurt US corporate profits, and productivity is declining. Local Government Spending to the Rescue? Locally, all one has to do to see the silliness of the idea that government spending will come to the rescue is look at dire state of places like Illinois and countless cities that still have not recovered from the recession (and won't). Is Chicago about ready to spend or does it want to raise taxes to make ends meet? For the answer, please see Chicago's Fiscal Freefall: Moody's Cuts Chicago Credit Rating to Two Steps Above Junk; Snake Oil and Swaps; It's All Junk Now. Also see Proposed Illinois Tax Hikes: Financial Transactions, Millionaires, Guns, Sweetened Beverages, Satellite Providers, Fireworks, Progressive Income. Wishful ThinkingThere is absolutely no measure of strong growth currently other than the lagging effect of jobs. (See Jobs and Employment: How Much Recession Warning Can One Expect?) In short, Nothaft parrots the wisdom of the vast majority of economists who have never once in history predicted a recession. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
| UBS on the Driver for Gold: What is Gold About to Tell Us? Posted: 30 Mar 2015 12:55 AM PDT An interesting article came my way from UBS analyst Julien Garran on the driver for gold. I do not have a link to share so excerpts will have to do. Garran's article is one of the better ones I have seen. Unlike others, Garran does not cite jewelry, mining capacity, central bank purchases or sales or other similar (and wrong) notions that unfortunately are widespread among most analysts. Commodities & Mining Q&A (by Julien Garran)
Q1. What drives gold?
A1. In the past, we've argued that international US$ liquidity is fundamental to calling first gold and then the industrial miners. In this note, we go a step deeper, arguing that gold is a call on excess returns in the US economy, the policy response and finally the impact on that policy on international US$ liquidity.
Q2. What is gold about to tell us?
A2. The key issues facing gold; excess returns in the US are under pressure as the strong US$ and falling energy squeezes cashflow. As wages pressures rise, weak productivity means that cashflows could be squeezed further. Both undermine credit conditions and threaten the longevity of the cycle. We believe the prospect of deteriorating liquidity magnifies the threat. That in turn is limiting the Fed's ability to tighten policy and may induce it to ease in the future. We think the Fed has started to recognise that pressure with its dovish backtracking at the March meeting last week.
A1&2. In commodity strategy, we believe that a forthcoming rally in gold may warn us that declining returns could ultimately force the Fed into a new round of international reflation. We think the first step was likely the Fed's dovish backtracking at the March meeting.
In the past, we've argued that gold behaves as a probability indicator of whether international US$ liquidity will be improving or deteriorating in six months' time. Industrial commodities are a call on whether international US$ liquidity is rising now.
So to call gold, and then the industrial miners, we have analysed the key drivers of those flows;
- The Fed
- The US current account deficit
- Bank's asset buying/accumulation
In this note we go a step deeper – arguing that gold is a call on excess returns in the US economy, the policy response and then finally the impact of that response on international US$ liquidity. We contend that the state of economy wide excess returns ultimately determine the longevity of the cycle, and so it is the progress of excess returns, above the intermediate targets on inflation & unemployment, that ultimately drive monetary policy.
Right now, excess returns are under pressure from four main areas; The rest of the world is exporting deflation to the US.
- The combination of rising wage pressure and low productivity/secular stagnation.
- A potential deterioration in liquidity.
- Deteriorating credit conditions and a rising Wicksell spread.
- Recent papers by Shin and McAuley hint at the reason.
The impact is visible in the deterioration in cashflow & EPS momentum, as well as in low trend US growth.
S&P Cashflow Momentum
S&P EPS Momentum
Rest of World exporting deflation to the US
As we've highlighted in our last note, international US$ liquidity has collapsed.
Secular stagnation, weak productivity & wage pressure
The second key threat to US returns comes from low productivity & the dearth of investment, itself induced by the high level of debt and the subsequent low rate of growth (See Buttiglioni – Deleveraging, What deleveraging? 2014).
The UBS house view, consensus and the Fed are all arguing that wages are due to accelerate. The Fed is watching several signs suggesting that labour markets are tightening and that wages are on the cusp of picking-up. Unemployment has fallen, the workweek has risen. Quits, a sign that the jobs market is tight enough to get people quitting work for better opportunities, are trending up.
And the Fed is watching professional wages trend-up. Its mental model is that median wages are attached by elastic to professional wages. When professional wages rise enough, median wages follow. There are clear anecdotal signs this is happening. Walmart and McDonalds have both announced a buck increase in basic wages in recent weeks. The impact is that labour costs are rising.
In the 90s rising wages promoted an extended cycle. Wages started accelerating in 1994. They accelerated from 1995-8. But cashflow held up. That was because of productivity. Robert Gordon, the godfather of the secular stagnation debate (see 'Secular Stagnation, 2014 – available free on the Vox website), highlights that total factor productivity rose at a 2.5% rate over the mid-90s. That was partly due to the burgeoning adoption and networking of PCs. And partly it was their increased use managing just in time inventories in a globalising, and lower cost, supply chain.
Of course, conditions are very different today. In 'Disinflation or deflation?' January 2015, we argued that deteriorating government productivity, something not measured in the GDP stats, was bringing down productivity for the economy as a whole. The combination of negative net investment and weaker productivity from tech applications means that corporates will struggle to offset rising wages.
US Productivity
So, in contrast to the extended 90s boom, weak productivity means that, as labour costs rise, cashflow gets squeezed, and credit fundamentals deteriorate further.
Liquidity & Credit Conditions
The most important support for US liquidity is corporate debt issuance for buybacks & M&A. So corporate debt issuance is also a key driver of EPS momentum. From 2010-14, corporates were able to issue large quantities of low quality debt.
In part, this was because there was a huge bid from mutual funds. Persistent Fed, foreign central bank and Investment bank treasury buying over the past five years induced mutual funds to reach for yield. But now that those sources of treasury buying have evaporated, mutual funds have much less incentive to reach for yield – so high yield appetite has deteriorated. Just as the fundamentals of debt, cashflows, are under pressure from the deflationary forces highlighted above.
Transmission Mechanism
The Wicksell spread The combination of low growth, weak productivity and deteriorating credit conditions put the cycle under increasing pressure. The Wicksell spread is the difference between corporate bond yields and nominal growth. Knutt Wicksell argued that a negative spread (with corporate yields below nominal growth) was like a subsidy to investment. A negative spread was increasingly a tax.
Late Cycle Signals
We have combined both cashflow and separately EPS momentum (giving them a negative sign so deteriorating momentum triggers a rise in the chart) and high yield spreads in our two 'late cycle' indicators below. The signals have spiked – suggesting that we are late in the cycle.
On each previous occasion that we have seen a spike of this magnitude in the indicators, we saw a significant market correction.
Our UBS proprietary Fed action model works on the basis that, over the past 20 years, the Fed has always reflated within two weeks if
- The S&P fell 20% from peak.
- High yield became stressed (HYG at 85 or below).
So, even though the Fed may focus on the intermediate targets of unemployment and inflation, it is ultimately the underlying sustainability of economy-wide excess returns that forces its hand.
The prospect of a more dovish Fed would set up the potential for a return of international US$ flows. A couple of recent academic papers by Shin & McAuley support the analysis. Excellent CommentaryGarran's commentary was excellent, and gratefully devoid of the typical focus on jewelry, mining, central bank purchases, and also manipulation theories. There is much more in the report, 24 charts in all, of which I posted six. Without explicit permission that is all I am comfortable posting. If I get a link I will add it as an addendum. There were no links in the article to things that Garran referenced, so I cannot provide those either. Fed Tightening Cycle Won't Go Far Reading between the lines, it seems that Garran, like I, does not think the Fed will get very far with the tightening cycle that most think is coming. One and done would not surprise me. Heck, no hikes at all would not surprise me. About the only thing that would surprise me is more than three hikes. US economic data other than jobs has generally been miserable. Don't expect a warning from the labor markets (See my article Jobs and Employment: How Much Recession Warning Can One Expect?) Indeed, data has been so bad that I think a recession is on the way. Negative Data Pours InEquities, Junk Bonds in for a Rough RideI don't know Garran's views on overall equities, but mine is the next round of liquidity will not have the same magic as the last two rounds, and in fact may even spook the markets. Add to that the fact that earnings have peaked this cycle and the potential for a huge downturn in equities and junk bonds is far greater than most think. Misunderstanding GoldIn case you missed it, please consider my March 27 article Misunderstanding "Peak Gold"; Gold About to Run Out? in which I debunked widely held notions that central bank asset purchases and sales, jewelry, and mining productions as drivers for the price of gold. Garran's analysis was a welcome refresher from the typical (and wrong) commentary we see about gold. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com |
