Friday, January 08, 2010

More of the Lost Decade, but No Inflation!!!

In my last post at The Sabrient Blog » Macro View of the Markets I was rhapsodic about the "undiscovered country." Since that time, I have had a chance to review some of my saved folders of bookmarks and ran across one entitled: Fed expected to lower rates despite raging inflation from MarketWatch. My goal is not to single out this one reporter {Rex Nutting} as being an inflation nutter but just to remind ourselves what the general mood of the time was.

And most certainly there were inflation nutters as well as stagflation hawks {vultures more like} that were predicting rising inflation levels based on just headline inflation as it included food and fuels that were rising faster than normal or when asked in more detail come around to talking about M3 monetary aggregate. Let me quote a section of the above linked article to get some more thoughts on these issues:
In a glorious bit of timing, the Federal Reserve is expected to cut interest rates on Tuesday for a third straight meeting, just days before government data are released showing some of the highest inflation rates in decades.

That's all you need to know about the Fed's balance of risks: Policymakers are much more worried about the illiquid credit markets and the possible hit that the credit squeeze could have on the economy than they are about the risks of inflation breaking out.

"Don't look now, but while we're in the midst of an easing cycle, the U.S. is facing a 4% inflation rate," wrote Avery Shenfeld, an economist for CIBC World Markets. "But for now, none of this matters, as both bonds and the Fed are focused on the credit crunch and its growth threat."

The economic data have been weak, but not disastrous, since October's meeting, when the Fed signaled that it thought it was done cutting rates. It's not the immediate economic situation that's brought the Fed back into the game of cutting rates, it's the horrendous condition in the credit markets, which are arguably worse off now than they were in August.

"The Fed is expected to reduce rates in response to evidence of very sluggish fourth quarter growth, and further stresses in the credit markets," wrote Brian Bethune and Nigel Gault, U.S. economist for Global Insight.

In hindsight, we have seen that the inflation fears were unjustified and the overall health of the economy has been sluggish due in part to credit markets ceasing up. During that time, I kept trying to get a grasp on how inflation was going to start the vicious cycle and what was going to unmoor low inflationary expectations. That bit of quandary I could never answer, so the conclusion I drew was that inflation was going to be low and somewhat stable for the core CPI. That does not mean that inflation could rear its ugly head as the Fed has been flooding the economy with trillions of dollars resulting in excess reserves in balance sheets of banks. And is one reason for this blog taking seriously the aspects of the general price level rises in the ISM reports, paying special attention to how many sectors/industries are experiencing rising price for inputs {including labor costs}.

Joseph Lazzaro also made similar conclusions to mine in the article entitled Ignore the circling inflation hawks in April of 2009. His conclusions are summed up by:
The real danger to the U.S. economy for at least the next two years, and probably well into 2012, is deflation, not inflation.

Humble Pie for all...
But in all humbleness, the severity of the housing crisis and the general contagion effect on other credit markets was beyond what I considered possible. Without a complete break down of the housing markets and analysis of the buyers as well as the originators of the loans, I still considered that housing stock is more than a simple investment decision but is an utility producing product for the consuming household. Thus once a family becomes a homeowner and puts that first coat of fresh paint on the walls it is more than just a place to sleep. Even if the mortgage is under water, what will make that family {that can make payments} to suddenly decide that renting from someone else is in their best interest? That was basically my question at the time.
Hawks of a Different Stripe.
Another attention grabbing headline from that time period is at MarketWatch entitled "Brazilian supermodel's wake-up call to U.S. 'Pay me in euros' underlines ills of our 'happy conspiracy' of greed". Putting aside that the super model is also simply looking out for own self interest as well as everyone else which some label as "greed", let me quote the relevant portion here about the headline:
And it'll ripple around the globe: The dollar's already lost 34% of its value since 2001. Can it get worse? Yes says Giselle Bundchen, a $30 million-a-year Brazilian supermodel who is demanding Pantene, an American cosmetic company, pay her in euros not dollars.

Why? As Bloomberg News put it, the dollar can "only depreciate because Americans ... are living beyond their means." What irony, a model delivers an economic policy warning with more punch than all the currency threats from Iran, Venezuela and China. Gisele's lucky. She's bailing out of the "happy conspiracy." You can't.

She may just consider that getting paid in a currency should be less about politics and more about personal consumption. It makes more sense that she would desire to be paid in currencies that she plans on using for her consumption.

From my first post here at: Deconstucting the Fed’s ‘Optimism Among Uncertainty’, we noted that the US currency had increased in value by 16.4% over a years time. Seems that abandoning the dollar was not the smartest move as to maximize returns. Even Warren Buffet/BERKSHIRE HATHAWAY INC. has lost money by shorting the dollar to the tune of around one billion. Just to remind ourselves the graph of the US dollar over the past couple of years:

Well that is all fine and good but what about going forward?
Sometimes I get asked as to what my opinion is on the economy or most recently on how the labor market will trend in the next year or so. Most of the time, I defer the question as beyond what I was intently looking at and studying. But this time I will go ahead and state that I think headline unemployment percentage will slowly creep down over the next year to 9% and continue on that trend for the next couple of years. That is still too high {IMHO} but it seems obvious that rates in the low 4 percentage range is a long time off even in the most rosy of forecasts.

Monetary policy has been pedal to the metal for at least a year and started in earnest about the time of the article sited above. So that has had plenty of time to have its full effect and the Obama stimulus will continue to distribute funds this year as well as just the automatic stabalizers in the fiscal budgetary process. Exports are increasing and the dollar is trending down to support these export markets, even if U.S. trade gap widens in November. Credit markets should open up as expectations rise as well as just the end of a normal business cycle. There is still the possibility that fear rising the levels of uncertainty and overall risks could damper the recovery when politics gets in the way of good economic sense, but with an election cycle coming soon then maybe not too much damage will be done by then.
No more lost decades?
So this makes me optimistic that we will not have another lost decade as Eric Fry states at Another Lost Decade?
Despite an abysmal 10-years of zero wealth creation and zero job growth, betting on a second consecutive Lost Decade seems like a bad wager. And yet, it happened in Japan…

Let me close with a graph of job growth by decades that says it all about our "Lost Decade":

Bernanke's Plan to Pick Your Pocket By Seth Jayson November 9, 2007

Brazilian supermodel's wake-up call to U.S. 'Pay me in euros' underlines ills of our 'happy conspiracy' of greed

First-time home buyers, who underpin market, are under pressure - MarketWatch

Toxic export: How U.S. subprime crisis contaminated world markets Special Report - MarketWatch

17 reasons America needs a recession Think positive, this 'slow motion train wreck' is good for the U.S.

13 reasons why Bush's mortgage bailout won't stop a recession Paul B. Farrell - MarketWatch

Uncertainty and the Slow Recovery A recession is a terrible time to make major changes in the economic rules of the game.

70% of Americans Think It's Harder To Get Rich Now Than It Used To Be New Bankrate poll shows that Americans are less confident that they and their peers can find wealth in 2010

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