Wednesday, October 27, 2010

Today's Best Reads

1--Too Little, Tim Duy, Fed Watch

Excerpt: Federal Reserve policymakers must be pleased with themselves. Market participants have fallen in line like lemmings off a cliff pursuing the obvious trades as the excitement over quantitative easing builds. Equities, bonds, commodities are all up. Dollar is down. Perhaps more importantly, measured inflation expectations have trended higher. Psychology is a powerful thing. Like leverage.

But like leverage, psychology can turn against you. The psychology of market participants forms on the back of expectations, which in this case is for the Fed to announce a significant expansion of the balance sheet on November 3. If the Wall Street Journal is correct, the Fed is poised to disappoint those expectations with an announcement of "a few billion dollars over several months." This looks like a clear effort to temper expectations....

Bottom Line: Right now... The US economy is operating below potential to the tune of about a trillion dollars give or take. The Obama Administration is poised to turn its attention to deficit reduction, seemingly oblivious to the historical errors of Japanese fiscal policy, not to mention the US experience in the Great Depression. For better or worse, that leaves monetary policy to bear the burden. But the Federal Reserve is signaling they are poised to deliver far less than necessary to meet expectations, expectations that already were likely overly optimistic. Truly, it boggles the mind, and suggests that Bernanke is far more worried about the specter of inflation than the real pain of unemployment.

2--"Scary New Wage Data", David Cay Johnson, Economist's View

Excerpt: Total wages, median wages, and average wages all declined, but at the very top, salaries grew more than fivefold. ...

Measured in 2009 dollars, total wages fell to just above $5.9 trillion, down $215 billion from the previous year. Compared with 2007, when the economy peaked, total wages were down $313 billion or 5 percent in real terms.

The number of Americans with any wages in 2009 fell by more than 4.5 million compared with the previous year. Because the population grew by about 1 percent, the number of idle hands and minds grew by 6 million.

The median wage declined by the same ratio, down $159 to $26,261, meaning half of all workers made $505 a week or less. Significantly, the 2009 median wage was $37 less than in 2000. (Wages are shrinking--except for earners on the top)

3--Case-Shiller: Home Price declines widespread in August, Calculated Risk

Excerpt: From S&P: Home Prices Increases Slow Down in August:

Data through August 2010, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show a deceleration in the annual growth rates in 17 of the 20 MSAs and the 10- and 20-City Composites in August compared to what was reported for July 2010. The 10-City Composite was up 2.6% and the 20-City Composite was up 1.7% from their levels in August 2009. Home prices decreased in 15 of the 20 MSAs and both Composites in August from their July levels.

4--Do Investors Expect Too Much From Bernanke?, Paul Krugman, New York Times

Excerpt: Financial markets seem convinced that quantitative easing will be highly effective at solving at least one problem: inflation running well below the Fed’s 2-percent-or-so target. The chart above shows the difference between interest rates on 5-year inflation-protected bonds (which are now negative) and rates on unprotected bonds; implicitly, the market forecast of inflation over the next five years has risen half a point.

But I really don’t understand this. Granted that QE2 will probably have some positive effect, hopefully bigger than analysis based on the debt-maturity equivalence suggests. Still, the prospect remains that we’ll face multiple years of high unemployment — or, if you prefer, a protracted large output gap (PLOG). And history is clear on what that means: declining inflation:...My guess, then, is that the markets are overreacting; they’re thinking, “The Fed is printing money!”, while forgetting that this ultimately matters, even for inflation, only to the extent that it seriously reduces unemployment.

5--Debt sales highlight abnormal conditions, Financial Times

Excerpt: The Fed has been sending the message that its cheque book is ready and it will do what it takes to reflate the economy,” said Jan Loeys, head of global asset allocation at JPMorgan Chase. “What no one knows is whether inflation will start to show in two weeks or two years.” Mr Loeys added: “We are seeing longer-term thinking clients becoming increasingly wary of bonds and hedging against inflation. Shorter-term thinkers are still willing to still buy bonds, on the presumption that they are nimble enough to get out when inflation comes to push yields up.” Long-term institutional buyers purchased 39 per cent of the $10bn Tips sale, up from an average share of 30 per cent for the prior six Tips sales....

Expectations for inflation over the next five years – based on comparing Treasury yields and those for Tips – have risen as high as 1.75 per cent this month, up from 1.13 per cent in August...(This will not end well)

6--Shape-Shifting Deficit Hawks, Baseline Scenario

Excerpt: 1. The traditional view. Large fiscal deficits will cause high interest rates, large government debts, and inflation.

“2. Declining business confidence is the real danger. Even if the current deficits have not caused high interest rates and inflation, they are eroding business confidence. When business confidence is low, the economy is highly vulnerable to small changes in conditions, what some economists call ‘non-linearities.’

“3. Fiscal stimulus policies never work. New Classical economists, Robert Barro most notably, have long argued that the multiplier for fiscal stimulus policies is zero or thereabouts.

“4. A long-term fiscal train-wreck is coming. Regardless of short-term considerations, we are courting disaster in the long-run with structural deficits that the recession has only worsened. (Simon Johnson refutes deficit hawk's arguments one-by-one)

7--Is there a bubble in the bond market, VoxEU

Excerpt: The yields on government bonds are at their lowest levels since the depths of the financial crisis in late 2008. On Monday 18 October, the yield on 10-year Treasury notes hit 2.52%, down from 3.85% at the beginning of the year. This movement is huge by the standards of the Treasury market. An investment in 10-year Treasury notes has returned about 11.4% this year.

The stock-bond correlation implies that investors currently view government bonds as a hedge against the possibility of deflation and low growth. Though they may be uncertain about the direction of inflation over the next five years, investors appear to believe that any increase in inflation will likely be accompanied by growth, making it less painful for their portfolios.

In evaluating the current level of bond prices, the critical question is whether investors are correct. If inflation will indeed be accompanied by growth, then nominal bonds should carry a negative inflation risk premium and correspondingly high prices. However, it is also possible that the economy could enter a period of stagflation with high inflation and low growth. In this case, investors should be charging a higher inflation risk premium, and bond prices should be lower today...

8--Economy is running out of gas, Rex Nutting, Marketwatch

Excerpt: In his latest forecast, Levy argues that deleveraging by consumers, banks, businesses, and state and local governments continues to hobble the economy. Balance sheets remain bloated by historic standards, which means the private sector will be saving more and spending less, probably for years to come. Federal government deficits made up for those private-sector savings, but only for a while.

Corporate profits were also bolstered by cost-cutting, especially by firing workers and cutting back the hours of the survivors. But in the aggregate, such tactics can’t be sustained, because reduced compensation across the whole economy ends up depressing corporate revenue. After all, consumer demand is dependent mostly on what consumers earn on the job.

Businesses aren’t investing, not because they don’t have the capital, but because they don’t see the demand coming back soon.

“Net fixed investment, normally the most important profit source, remains less than 2% of GDP (the postwar range until the last recession was about 4%-10%) with limited prospects for improvement in the year ahead,” Levy wrote. “Deep problems mar the outlook for investment in commercial and residential structures, while overcapacity and slow topline growth expectations limit the potential of the present spurt in capital equipment outlays.” (Lots more)

9--Arundhati Roy faces arrest over Kashmir remark, Guardian

Excerpt: The Booker prize-winning novelist and human rights campaigner Arundhati Roy is facing the threat of arrest after claiming that the disputed territory of Kashmir was not an integral part of India.

India's home ministry is reported to have told police in Delhi that a case of sedition may be registered against Roy and the Kashmiri separatist leader Syed Ali Shah Geelani for remarks they made at the weekend.

Under section 124A of the Indian penal code, those convicted of sedition face punishment ranging from a fine to life imprisonment.

Roy, who won the Booker in 1997 for The God of Small Things, is a controversial figure in India for her championing of politically sensitive causes. She has divided opinion by speaking out in support of the Naxalite insurgency and for casting doubt on Pakistan's involvement in the 2008 Mumbai attacks.

"Threatening me with legal action is meant to frighten the civil rights groups and young journalists into keeping quiet. But I think it will have the opposite effect. I think the government is mature enough to understand that it's too late to put the lid on now," Roy said.

"Pity the nation that has to silence its writers for speaking their minds. Pity the nation that needs to jail those who ask for justice, while communal killers, mass murderers, corporate scamsters, looters, rapists, and those who prey on the poorest of the poor roam free."

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