Wednesday, April 6, 2011

Today's links

1--The good, the bad, and the Fed, Tim Duy, Fed Watch via Economist's View

Excerpt: In sum, the economy looks to be on, as the Fed describes, “firmer footing.” Definitely good. But definitely not without warts. Housing, for example – a market that just won’t heal in light of a very big structural change toward tighter underwriting conditions. Yet the biggest wart is simply that the pace of growth appears to ensure the economy operates far below potential for far too long. This is the “bad.” As a consequence, unemployment is retreating slowly. Arguably, we wouldn't mind if unemployment increased a bit if growth was sufficiently strong to draw a mass of persons back into the labor force. But labor force participation fell to 64.2 percent and held there for three months...

Likewise, the employment to population ratio shows no indication of rebounding to prerecession levels anytime soon. At this rate of recovery, I am generally worried that the next decade will prove to be once again “jobless,” that nonfarm payrolls will once again remain stagnant by the time we are near the trough of the next recession. Maybe this is what inevitably becomes of aging economies.

The palpable weakness of the labor market reveals itself in stagnant wage growth. Average hourly earnings gained just a penny in February, and nothing in March. Workers might be feeling the effect of headline inflation, but apparently have absolutely no power to respond with anything but belt tightening. The lack of wage growth is simply the biggest hole in the inflation story, as it suggests that underlying inflation inertia is practically nonexistent. That this is not obvious to all monetary policymakers is somewhat shocking. spencer at Angry Bear puts it succinctly:

The combination of expanding hours and very weak wage gains generated an increase in average weekly earnings. But the year over year increase in average weekly earnings is only 2.87% this month versus 2.98% in February. With weekly earnings only growing at under a 3% rate it is hard to see how firms can pass higher commodity prices through to consumers.

The inflation hawks seem to be ignoring the point that higher prices or inflation is most likely to generate weak consumption, not sustained higher inflation. Managers and analysts appear to be far too optimistic about firms ability to raise prices....

Bottom Line: Monetary tightening will come. At least, we all hope it will. I shudder at the prospect of being stuck here for another three years. But I think it premature to expect that tightening anytime soon. The core of the Fed will keep focused on the pace of growth relative to the depth of the recovery. The current recovery may be sustainable, but continues to fall short of that necessary to propel output and employment to prerecession trends. And clearly short of that necessary to induce more rapid wage gains. The data simply are not there to justify a monetary policy shift at this juncture.

2--Fed’s Evans: Without Wage Hikes, Little inflation pressures, Wall Street Journal

Excerpt: Federal Reserve Bank of Chicago President Charles Evans became the latest to add his voice to the recent cacophony of Fed chatter, saying the central bank’s asset-purchase program will likely end in June and “would not be surprised” to see a rate increase take place in 2012.

While the U.S. economy has improved “quite well” since last fall, Evans said in an interview on CNBC that he would like to see even stronger jobs growth that includes rising wages in order to boost inflation to what he considers an “appropriate” 2%. Evans is a voting member of the rate-setting Federal Open Market Committee this year.

“We are one percentage point too low [on inflation],” Evans said in the interview.

Without a pickup in wages, inflation will unlikely see significant upward pressures, even though food and energy prices have been rising, Evans said. He said the economy would need to see those pressures work their way through to second round prices increases, but that he’s “not looking for that to take hold.”

“I don’t expect inflation to move up quite as much” as my peers, Evans said in the interview. “As long as core inflation is under 1.5%, we’re going to continue to feel better about having an accommodative policy in place than something other than that.”

3--Why We Must Raise Taxes on the Rich, Robert Reich's blog

Excerpt: Here’s the truth: The only way America can reduce the long-term budget deficit, maintain vital services, protect Social Security and Medicare, invest more in education and infrastructure, and not raise taxes on the working middle class is by raising taxes on the super rich.

Even if we got rid of corporate welfare subsidies for big oil, big agriculture, and big Pharma – even if we cut back on our bloated defense budget – it wouldn’t be nearly enough.

The vast majority of Americans can’t afford to pay more. Despite an economy that’s twice as large as it was thirty years ago, the bottom 90 percent are still stuck in the mud. If they’re employed they’re earning on average only about $280 more a year than thirty years ago, adjusted for inflation. That’s less than a 1 percent gain over more than a third of a century. (Families are doing somewhat better but that’s only because so many families now have to rely on two incomes.)...

Yet even as their share of the nation’s total income has withered, the tax burden on the middle has grown. Today’s working and middle-class taxpayers are shelling out a bigger chunk of income in payroll taxes, sales taxes, and property taxes than thirty years ago.

It’s just the opposite for super rich.

The top 1 percent’s share of national income has doubled over the past three decades (from 10 percent in 1981 to well over 20 percent now). The richest one-tenth of 1 percent’s share has tripled. And they’re doing better than ever. According to a new analysis by the Wall Street Journal, total compensation and benefits at publicly-traded Wall Street banks and securities firms hit a record in 2010 — $135 billion. That’s up 5.7 percent from 2009.

Yet, remarkably, taxes on the top have plummeted. From the 1940s until 1980, the top tax income tax rate on the highest earners in America was at least 70 percent. In the 1950s, it was 91 percent. Now it’s 35 percent. Even if you include deductions and credits, the rich are now paying a far lower share of their incomes in taxes than at any time since World War II....

All the President has to do is connect the dots – the explosion of income and wealth among America’s super-rich, the dramatic drop in their tax rates, the consequential devastating budget squeezes in Washington and in state capitals, and the slashing of vital public services for the middle class and the poor.

This shouldn’t be difficult. Most Americans are on the receiving end. By now they know trickle-down economics is a lie. And they sense the dice are loaded in favor of the multi-millionaires and billionaires, and their corporations, now paying a relative pittance in taxes.

The President has the bully pulpit. But will he use it?

4--Is Quantitative Easing Working?, Modeled Behavior

Excerpt: When I was pushing for greater Fed stimulus I had two primary mechanisms in mind.

The decline of the dollar

A decline in corporate cash holdings

As Krugman notes we see that the dollar has declined and that net exports have been a major contributor to the recovery – as one would predict....Now what about corporate cash. The data from the flow of funds report isn’t fresh enough to tell. The last report in October of 2010 had corporate cash still rising...What about other proxies for the release of corporate cash. Below is year over year change in new orders for Capital Expenditures Excluding Aircraft....Nothing that we could call a QE2 surge. Indeed a bit of a drop off.

How about wage and salary disbursements?

A rise but again nothing we could call a QE2 surge....

At this point it looks like the corporate cash channel is not moving.

On the other hand US asset prices do seem to be rising. As Krugman mentions this is a plausible channel. Indeed, I think Scott Sumner focused a lot on this channel. Its not, however, a channel that I had previously considered important.

I am also not sure it is consistent with my view of the macro-economy. Yes, consumer spending should rise if asset prices rise, however, those should both be a response to higher expected future profits. So what’s causing higher expected future profits? It can’t simply be higher spending because that’s circular.

It could be that be that a cheaper dollar implies both more sales and higher value sales of US exports which in turn implies higher profits which in turn juices consumer spending. In that way that asset effect is like a multiplier.

Perhaps, but off the cuff the rise in consumer spending seems to large to make sense through that channel.

On balance I would say that the evidence suggests that much of the boost in consumer spending is not through channels consistent with my theory of monetary policy and quantitative easing.

While I would like to claim victory in the intellectual battle over QE, at most the export story is my favor. The rest is not.

5--What's causing commodities to soar, Pragmatic Capitalism

Excerpt: If you’ve been looking for an honest assessment of the recent commodity rally look no further than this bit of research by the BOJ. They provide a broad overview of the factors that are currently impacting commodity prices and conclude with a practical and fact based argument – global central banks, the financialization of commodity markets and supply/demand mechanics are all working in tandem to cause a perfect storm in commodity prices. They write:

“While the strong increase in commodity prices has been driven by global economic growth propelled by emerging economies, speculative investment flows into commodity markets have amplified the intensity of the price surge. The dynamics of global commodity prices has been changing as well, in accordance with the growing presence of financial investors in commodity markets. The entry of new financial investors has paved the way for the “financialization of commodities”. Consequently, global commodity markets have become more sensitive to portfolio rebalancing by financial investors, which has made commodity markets more correlated with other asset markets, including major equity markets. Furthermore, globally accommodative monetary conditions have played an important role in the surge in commodity prices, both by stimulating physical demand for commodities and driving more investment flows into financialized commodity markets.”

Unlike the SF Fed, which just yesterday absolved the Fed of any impact on commodity prices (in fact said QE2 was exerting downward pressure on commodity prices), the BOJ performs multidimensional & unbiased research that finds the Fed and global central banks are having a dramatic impact on commodity prices. Of course, they’re not entirely to blame, but these unbiased findings put a very serious hole in the persistent Fed talk that attempts to distance them from the commodity price increases. In my opinion, this is the most precise and accurate conclusion I have seen with regards to this subject.

6--The decline in the dollar means QE2 is working, right?, Pragmatic Capitalism

Excerpt: Pundits like Krugman will be quick to claim the declining dollar is helping exports, but neglect the negative impact of surging commodity prices (most of which are priced in dollars). On the bright side though, we can now confirm (thanks to the SF Fed) that QE2 is putting downward pressure on commodity prices (yes, they really are making this claim). Back on planet earth, however, the impact of higher input prices is having a real impact. As you can see the USD decline has coincided with a 36% surge in the CRB Index and 66% increase in gasoline prices. If Deutsche Bank’s analysis is accurate then the gas price increase alone has nearly wiped out the entire positive impact of the recent tax cut...

And this is all flowing right through to the bottom line in REAL GDP. Contrary to the opinions of the SF Fed, commodity prices really are rising in tandem with QE2 and having a material impact on inflation, consumer spending and real growth...

The latest revisions to GDP show that the pace of the economic expansion is slowing (actually peaked right at the initiation of QE2!) and the downgrades for Q1 2011 are rolling in by the truckload now. Goldman Sachs & Bank of America are both expecting just 1.5% growth….QE2 success? If 1.5% real GDP is success then yes, break out the party hats. Unfortunately, the evidence regarding the USD, QE2 and its success is mixed at best and likely skewed more towards the negative than the positive...

7--U.S Debt Nears Ceiling, Hits Record $14.21786 Trillion, Wall Street Journal

Excerpt: Total U.S. debt hit an all-time high of $14.27011 trillion on Thursday and is nearing the federal debt ceiling as Washington intensifies the debate over debt and government spending.

The federal debt ceiling is set by Congress and was last raised to $14.29 trillion. Because not all U.S. debt counts towards the ceiling, total debt subject to the ceiling was $14.21786 trillion as of Thursday, according to the most recent government data available. That gives the U.S. less than $80 billion in headroom before it hits the ceiling.

Treasury officials said several weeks ago the U.S. could hit the ceiling as soon as April 15 and have urged Congress to raise the limit.

The country can’t issue debt once it hits the ceiling, which a number of experts, including Federal Reserve Chairman Ben Bernanke, have warned would be “catastrophic.”

In February, Treasury Secretary Timothy Geithner urged Congress to raise the debt ceiling by March 31, but Congress so far hasn’t agreed on how to tackle the issue.

8--Appetite Grows for Exotic Asset-Backed Securities, Wall Street Journal

Excerpt: The hunger for exotic asset-backed securities is growing, even as the broader market for the investments continues to shrink.

The securities are backed by student, auto and credit-card loans, and new issuance has fallen every year for five straight years, shrinking by some 81% over that period. Some $25.17 billion worth of asset-backed bonds were sold this year though March, according to data from Citigroup Inc.

That’s down from $31.54 billion over the same period last year. This doesn’t include bonds backed by mortgages for homes or shopping malls, office complexes and hotels.

Industry participants expect a pickup later this year with increased sales of more exotic, higher-yielding issues, such as those backed by timber harvests, timeshare revenue and cellphone-tower leases. By Thursday, such “off-the-run” bonds valued at $1.89 billion were priced, according to Citigroup data. That’s a fraction of the $16.18 billion of auto-sector bonds sold so far this year.

Even though they comprise a smaller portion of the market and are considered riskier, investors like money managers, insurance companies and hedge funds buy them because they yield more than auto or student loan-backed bonds....

The Federal Reserve propped up the asset-backed securities market during the financial crisis through a program called the Term Asset-Backed Securities Loan Facility, or TALF. The $200 billion program, which lasted from March 2009 until June 2010, provided low-cost loans to investors buying nonmortgage asset-backed securities after the market dried up.

At its peak, about $700 billion of securities backed by auto and student loans and credit card debt were sold. Issuance withered to about $135 billion in 2010, according to data from Asset-Backed Alert, a trade publication. Estimates for this year’s issuance are in the same range....

For conventional ABS bonds, though, the breadth of the investor base “has recovered to precrisis levels,” said Brian Wiele, head of Americas securitization syndicate at Barclays Capital. Issuance has been steady this year, he said, adding that he expects that to continue as the economy picks up.

9--Deflation is still the issue, Comstock Partners via Automatic Earth

Excerpt: There Still Is No Viable Solution To America's Debt Crisis...

Our feeling, as long-time readers will not be surprised to hear, is that this enormous debt will not be inflationary but deflationary instead. If this is the case, the stock market is headed much lower and the economy will either go into a double-dip or have such a sluggish recovery that it will feel like one. There are the two main reasons we are so convinced that we will not be able to inflate or grow our way out of this mess.

First, the massive increase that QE1 and QE2 has generated in the monetary base has not been translated into anywhere near a commensurate rise in money supply (the so-called "money multiplier").

Second, the subdued rise in the money supply to date has not resulted in a big increase in GDP (the so-called "velocity of money")-.

In addition, the loose fiscal policies cannot generate the borrowing and spending that is required to get the money supply up enough to drive the economy and inflation higher. The velocity of money is also influenced by interest rates. When rates are low, people hold more money in cash. On the other hand, when rates are rising, they put more money in interest paying investments. The low rates, as we have now, results in a "liquidity trap", which is what Japan has also experienced over the past 21 years.

Unless we escape this "trap" there will be massive deleveraging by the sector that drove us into this mess. Household debt rose from 50% of GDP in the 1960s, 70s and 80s and eventually doubled to close to 100% of GDP presently. This debt will either be defaulted on, or paid down until we get back to the norm of around 50% of GDP again. This will bring household debt down below $10 trillion from $13.5 trillion now.

Another reason that makes us so convinced that the "debt situation" will be resolved by deflation and not inflation is the political environment that is currently sweeping the nation. The Republicans and Tea Party congressmen and governors that were recently elected ran on a platform of cutting government expenditures, cutting back on entitlement expenditures, and doing whatever possible to pay down the debt.

In fact, the bipartisan "Debt Commission" that was sponsored by President Obama, came up with a number of austerity measures that would cut the deficit substantially over time. The big problem, however, is that any austerity program implemented now will only exacerbate the ongoing deleveraging of this debt and throw the economy into recession.

There are two more reasons that we believe the onerous debt incurred over the past 30 years will wind up with a painful deflationary bear market rather than inflation or hyper-inflation. First, the high cost of necessities such as food and energy is much more deflationary than inflationary.

Since wages have been static for years, the high cost of these necessities acts to reduce real disposable income. This, in turn, reduces what the average consumer can purchase with his or her disposable income. More money spent on energy and food simply means less money to spend elsewhere.

In order for easy fiscal and monetary policy to result in significant inflation there must be a transfer mechanism, and that mechanism is a rise in wages by an amount at least enough to enable consumers to pay the higher prices. That just doesn't look as if it is going to happen....

It is fortunate that these problems are better understood. But, the public's view of the resolutions (grow the economy and/or inflate), will be much more difficult than they think as long as "velocity" remains low. Although we believe the eventual result will be deflationary, we still put only about a 65% probability on that outcome, a 30% probability of an inflationary outcome, and only about a 5% chance of being able to grow our way out of the problem.

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