Federal Reserve Board

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Actual News Not in Davos

In solidarity with the Chinese government I have decided to forego my trip to the annual Davos shindig. I am willing to overlook the fact that, for the second year in a row, my invitation arrived late. Actually it didn’t arrive at all. But I refuse to attend during the Chinese New Year celebrations. How myopic can these folks get? They arranged an international economic forum slap bang in the middle of the new year. Well done. It’s not as if the Chinese are an important factor on the world economic stage or anything.

This gives me a little extra time to dwell on the news here at home.

The US real estate industry closed out an abysmal year with a thud. December’s new homes sales figures were dismal, coming in at 2.2% down from November and scraping along at an annual rate of 307,000 units. That’s a record low. Such is the depression in housing the the US is fast beginning to suffer from a shortage of new homes. Worse: what inventory we have is in all the wrong places, so there is local abundance where there is no demand, and local shortages where demand has survived. Way to go free market!

Overall sales of new homes fell 6.2% in 2011 to a record low of 302,000. Compare that with the peak reached in 2005 of 1,280,000. This is the worst year for sales since records began in 1963, and there doesn’t appear to be much sign of a break out.

December’s rotten record comes despite very favorable conditions: the weather was relatively warm in those parts to they country where winter can cramp sales; interest rates are low so mortgages are cheap; and prices are being heavily discounted as builders try to salvage something from the debris of the industry. None of these factors was sufficient to entice buyers, who remain in heavy retrenchment mode focused on debt reduction rather than new big ticket purchasing.Today’s report reinforced the gloom of yesterday’s news about pending home sales which were down 3.5% in December, which merely adds to the notion that there is no recovery in sight.

The only glimmer of hope – and it is only a glimmer – was the news that the FHFA index of home prices ticked up 1% in November. This index is created using the rates on government guaranteed mortgages only, so its is a relatively limited sample. Plus it is not a measure of the re-sale value of homes which is better captured by the Case-Shiller index. It really doesn’t matter though. Both indices say the same thing: home prices are down and seemingly are staying down. In the case of the FHFA home prices were down 1.8% for 2011 as a whole, and are off 18.8% from their peak in 2007. The Case-Shiller index is less up to date. The last data we have was released in late December and covers 2011 up to October, when prices were down roughly 3.0% for the year. The key point being made by the Case-Shiller index is that the recovery in prices we saw back in 2009/2010 has ben reversed somewhat, with the market softening throughout last year.

Meanwhile the Fed had made significant changes to the way in which it tells us what it’s doing. It has made public its medium term expectation for interest rates in an attempt to be more transparent about monetary policy. It also made public its inflation target.

The key news from the Fed is that it expects to hold short term rates at their current levels through until the end of 2014. That is not good news. It implies that the Fed doesn’t see robust growth during that period, or at least sufficient growth to force a tightening of monetary policy. The economy really does suck as much as we all feel it does.

One impact of the Fed’s announcement was to bring long term rates down. This was obviously part of the Fed’s intention. The markets now have a very clear idea of the rate structure over the next few years. This lessens risk and makes investment more straightforward. Today’s reaction in the credit markets saw rates on the five year Treasury bond down below 2%, with the two treasury rate slipping to 0.2%. At these levels we need a microscope to detect a slope in the yield curve. On a serious note: these kind of rates mean that a five year bond is almost as good as cash. This is uncharted territory, and bears close attention.

The other announcement the Fed made, about the target inflation rate being 2.0%, was a bit of a downer. That’s too low. As we try to spark a little life in our stagnant economy a couple of years of 5% inflation would help to hasten debt reduction and thus to free up cash for consumption. No such luck. Although with recent inflation being between 1.5% and 2.0%, we are clearly below the target and thus have no reason whatever for tightening. On the contrary: we are under-shooting the target. This is a reason to try to inject a little inflation. At the very least we look set for years more of very loose money.

One last thing: today’s report on new claims for unemployment assistance showed a retreat from last week’s improvement. There was a sharp climb back to 377,000, which was more than most analysts expected. The data has bounced around a bit lately because of the ebb and flow of seasonal jobs. The seasonal adjustments seem to have exaggerated the improvement last week and, perhaps, the worsening this week. The four week average has seen a slight steady gain, and it too has arrived at the 377,000 mark. The best we can say about the job market is that its tone has improved a bit from the beginning of 2011, but not significantly enough to be called a breakthrough.

We have a long slow slog ahead.

That is unless we get more enlightened economic policy. The odds of that are less than of me winning the lottery. Which makes the prospects for further stagnation a sure thing.

And that’s not good at all.

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Inflation and von Mises

Yesterday I speculated that the decline in the cost of basic goods like gasoline was a contributory cause of the uptick in retail sales in October. Today’s consumer price report supports that notion.

The headline rate of inflation, the consumer price index, declined 0.1% last month bringing the rate for the last twelve months down to 3.5%. That’s a large decline in the annual rate – in September it had been 3.9%. In contrast, the more important “core” rate, which strips out volatile items such as gasoline and food, rose 0.1% and has risen 2.1% over the last year. The biggest factor behind the decline in the headline rate was a 2.0% drop in energy prices, while food prices rose, but only a slim 0.1%.

The decline in the CPI, coupled with a very slight increase in hourly wages, meant that inflation adjusted earnings rose 0.3% for the month. This modest improvement in incomes appears to be the basic reason retail sales were slightly stronger than expected.

The importance of this report is simply that it debunks, or helps to at any rate, the notion that expansionary monetary policy deployed to get the economy going will inevitably feed into inflation. This is a view held by many right wing analysts, and has no substance or foundation, but exerts a tenacious hold on their thinking. It has it modern roots in the writings of von Mises, and still occupies a leading role in right wing economic policy thinking even though such right leaning luminaries as Milton Friedman considered the idea daft. If you recall we were treated to an outburst of terrifying warnings of imminent hyperinflation this summer when commodity prices drove the CPI up temporarily. The cause of those warnings was the right winger’s view that recent Fed actions such as QE1 and QE2 could only create inflation and not help the economy. In von Mises words:

“Attempts to carry out economic reforms from the monetary side can never amount to anything but an artificial stimulation of economic activity by an expansion of the circulation, and this, as must constantly be emphasized, must necessarily lead to crisis and depression”

There’s not much wiggle room in those words. The analysis is definitive: tinkering with the money supply necessarily leads to crisis and depression.

That it hasn’t, ought, in a scientific world, permanently disprove von Mises’ view. It won’t. It will linger on because of its ideological purity. But it isn’t science.

But we could say that about a lot of economics.

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News not Greek

It is hard at the moment not to be mesmerized by the melt down of the Euro. One moment we are told a major position has been established. The next, what was impregnable crumbles to dust in the face of inexorable economic and financial logic. As I see it default is both inevitable and desirable. Inevitable because the burden of debt on top of horribly ill-conceived austerity measures is creating a social backlash that cannot be resisted. Desirable because it would give space to the Greek economy within which much needed reforms can take place without undermining civil society. Desirable also because creditors need to be disciplined just as much as debtors: they need to be reminded that lending is a risky game, and that losses are a natural part of the process of banking. Both buyer and seller need to beware. Stuff happens, and money may not get paid back.

Meanwhile in news not Greek:

The US economy meanders along in it well established stagnant rut.

This week you may not have noticed the news amidst all that Greek drama – on a personal note, my late father-in-law was Greek and grew up in the town of Drama, so he would have enjoyed the current dramatics on a decidedly personal level. Here’s a brief summary of this week’s action:

The Chicago index of industrial activity slipped from 60.4% to 58.4% this month. This supports the general notion that things are not accelerating, but that they are still not collapsing either.

On a slightly more worrying note, the Institute of Supply Management’s measure of manufacturing edged down also, to 50.8% in October from 51.6% in September. Neither of these readings is particularly strong – a reading of over 50% indicates more companies are expanding than contracting. Obviously if we slip any further we should all be concerned that we are seeing the beginnings of a more broad contraction. That October result is perilously close to the borderline. So this index bears watching over the next few months.

Worrying too was the drop in construction spending, which has hardly been robust of late anyway. The latest figures are for September when construction eked out only a 0.2% gain. August had seen a 1.6% gain, so things have slowed down a bit, from rotten to really rotten. This decline didn’t make the headlines, however, because most forecasts had been for an even worse result, and weather may have distorted things too. Still, there is no sign of an incipient boom anywhere to be found. The meander continues.

Lastly, and to support the prognosis of stagnation, today’s ADP report on private payrolls is nothing to write home about. The private sector added 110,000 jobs in October. This is neither good, nor atrocious. It is down slightly from September’s 116,000, but not significantly enough to worry about.

All of this sideways motion contributed into the Fed’s decision to stand pat on monetary policy. The two day Federal Open Markets Committee meeting concluded this morning with a rather tepid press release. At this point I usually launch into a tirade about the Fed’s hawks because they perpetually interpret all this mediocre news as a sign of an imminent burst of growth, sufficient to cause rapid a inflationary spiral. They are thus normally on the side of caution and want to see the Fed start to undo its easing and to tighten things up. How they arrive at this position I have no idea, they seem to be content to ignore the actual evidence and to rely, instead, on fantasy visions and doom laden scenarios in their minds.

But, not today. The only dissenter from the Fed’s current position sees things as more gloomy than me. He wants more easing. This is so unusual I have to bring it to your attention. When even the hawks are quiet, and when the only dissent is on the side of easing, the economy cannot be in the rosiest of shape.

That our hawks are quiet is of little help in global terms. The crazies running the European Central Bank seems intent on being horribly destructive. Those hawks make ours look positively sparrow like. The economists at the ECB qualify for the title of ‘weapons of mass destruction’. Perhaps the US should invade the ECB on that pretext?

Oh. Wait. We used that excuse already.

How did that work out?

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Stutter Applause?

Since when did we all get excited over mediocrity? I have been suffering from all sorts of technology problems this week and so have been more an observer than a commenter on latest trends. I have learned that it is quite possible to drop out of the daily grind of data and not miss anything. Nothing has changed.

Nothing in the data.

Nothing in the politics.

Nothing in the policy.

Nothing at all.

Everything suggests we are adrift and will remain so.

Yet we are treated to breathless analysis by experts who hang on every nuance as if it represents a sea change.

Take, for instance, today’s “Beige Book” release. As its name suggests this is hardly an exciting compendium. It is an internal document circulated within the Fed summarizing anecdotal and other reports from the various Fed districts. It purports to give an up to the minute view of local economic activity and is a supplement to the steady flow of more formal information from government and industry sources. By and large it is rather dull. Nonetheless it provides useful color to the Fed’s internal policy discussions.

Today’s Beige Book describes a very weak economy with only a few – energy, autos, and tourism – bright spots. Yes, there is growth. Pathetic growth. The economy is still expanding, just not very quickly.

So why was its release greeted with such enthusiasm?

I suppose it could have been worse.

When we are supposed to get worked up over weak reports because they are not as bad as we feared they might be, we are clearly in a mess.

Another good example of this defeatist syndrome is the news, released earlier this week, that real estate construction businesses are more optimistic about the outlook this month. The construction industry’s outlook is surveyed monthly, and has been, as you would expect, stuck firmly in the doldrums for a very long time. This week, though we were told that the industry is more upbeat. Good. But look at the numbers: last month the index measuring the level of optimism stood at a near all time low of 14. That’s truly awful. This month things have really looked up. Now the index stands at 18.

What am I supposed to say?

That is also truly awful, just not as bad as the previous month. In any other month prior to this crisis a reading of 18 would have sent analysts running for the hills. Now we are treated to headlines lauding an improvement and a possible turn around.

Frankly that’s ridiculous.

The economy sucks.

It is going to stay that way, and possibly drift down a little, because our leadership is locked into a combination of incompetent policy making and ideologically driven trench building in preparation for an election that is still over a year away.

So we applaud the stutter. We have nothing else to do. And we are embarrassed about the way in which our elite is so obviously bereft of ideas, courage, and anything resembling a leadership quality.

But they do feel our pain.

Some of the more amusing comments this week have been those coming from our business leaders who apparently have noticed that the locals are getting a little restless. So they are lining up to make suitably sympathetic noises about how much they are also angry about the economy, the level of unemployment, and lack of wage growth.

They really feel our pain.

Personally I find it comforting that the very people responsible for our economic ills, and the extraordinary inequality that is tearing at our social fabric are worried about the consequences of their actions. Well not really. I don’t think they mean it at all. But their public relations departments evidently feel a need to ensure that their respective CEO’s express concern. I imagine they think we don’t understand the hypocrisy of a CEO whose business ships jobs abroad at the first sighting of potential profit, and who then turns around and sobs over the lack of progress in reducing unemployment.

I have an idea for this particular CEO: bring the jobs back!

Oh, wait, that would damage shareholder value, so we can’t do that, can we?

Setting aside my understandable cynicism, I think we can detect the first signs of reaction from the 1%: they are beginning to notice, albeit only vaguely, that something is wrong. Profits, don’t forget, are at seventy year highs, so people whose incomes depend upon income from capital are not feeling the same pinch everyone else. So for them to begin to make paternalistic statements about the pain they feel can be ascribed to the fact that the anger is seeping into even the most resistant of regressive ranks. Heck, even Eric Cantor, hardly a doyen of the progressive cause, is going to make a speech addressing inequality. I have no idea what he could possibly say. After all the current state of play is largely a direct outcome of the policies he has espoused his whole political life.

Perhaps there are cracks in those regressive ranks.

Meanwhile applause for the ongoing stutter rings so hollow. It’s better than nothing. It isn’t much. A ship being rudderless is generally not something we regard in a positive light, but at least we aren’t stuck on the rocks.

We aren’t, are we?

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The Fed Acts

Look for Bernanke to be burned in effigy at the next meeting of the Republican Party leadership. In defiance of the brazen attempt to interfere with Fed independence by that leadership – if that word is appropriate – the Fed announced today that it was going to engage in yet another new trick in order to support the economy. Citing continued, and possibly worsening, economic weakness the Fed unveiled a new trick.

It is a variant on the “twist” strategy last deployed in the 1960’s. In this latest version the Fed will sell off about $400 billion in short term treasury bonds, and buy an equivalent amount of longer term bonds. The idea being that this will influence the slope of the yield curve – the difference between short term and long term interest rates. A large shift into longer term, and thus more risky, assets should drive those rates down. By adding its own demand to the normal market demand for longer term securities the Fed will have the effect of driving down their interest rates. Conversely it will, of course, have the opposite effect at the short term end of the maturity spectrum. The net result will be to reduce the risk premium on longer term assets and thus makes investment more attractive. The desired outcome of the entire effort being to encourage business and household investment by reducing the cost of borrowing in the range of maturities normally associated with private sector activity in the real economy.

Will it work?

Well the 1960’s attempt at a similar thing is widely regarded as a flop. But circumstances were different back then. Now we are in a liquidity trap; businesses are awash with cash; and households are still digging out of debt. This is not an auspicious combination. So the context for the Fed’s initiative is not good. Still, we should give them marks for effort. Which is more than we can say for the folks over in Congress. There, it seems, all the effort is being applied to doing nothing.

As an addition, and just to rile the Republicans even more, the Fed also said it was going to reinvest more of its maturing cash flows in mortgage backed securities rather than in regular Treasury bonds. This is aimed to help provide more help to the real estate market, via an inflow of liquidity. Again, it might have little effect. But at least Bernanke is trying.

One last thing: the usual suspects on the Fed Board opposed the initiatives. Those people – Plosser, from Philadelphia; Fisher, from Dallas; and Kocherlakota, from Minneapolis, all objected to any kind of stimulative effort. According to these three the economy is in ruddy health, needs no help, and thus any stimulus will ignite horrible hyperinflation. They have all been wrong consistently since the crisis erupted, so it is re-assuring to see them maintain that consistency. It means we assuredly need to do something. Probably a lot more drastic than what was announced today.

But we are forced to accept what little help we can.

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