Posted by Michael A. Kamperman on October 28, 2009
Next week the Federal Open Market Committee will meet to determine whether to or not to change their near zero interest rate policy and whether or not to signal an exit strategy from quantitative easing to those concerned about runaway inflation and the fall of the dollar. Absolutely without a doubt the Fed needs to ignore the voices calling for a clear exit strategy and needs to up their program of quantitative easing to purchase more U.S. Treasury bonds. The real economy remains in terrible shape and deflation is gaining traction in the U.S. and global economy. Without a boost from the first time home buyers tax credit new home sales started falling again in September, because there was no longer enough time to complete a new home and close by the November 30 deadline. Consumer confidence numbers are falling hard again, which will further dampen consumer spending. This is also a clear signal the job market has a giant need not apply sign attached to it. The Fed cannot meet its mandate of full employment without being much more aggressive by printing more money.
Following World War I the Weimar Republic of Germany faced numerous challenges. They were saddled with crippling debts known as war reparations and they were facing inflation rates running as high as 60%, because wealthy Germans sought to move cash to hard assets and foreign assets as quickly as possible. It was into a high inflationary environment with full employment that the Weimar Republic chose to indiscriminately print money. Additionally, the rest of the world did not share Germany’s problems and currency traders were able to punish the Mark on global currency markets. We are in a deflationary environment and we have high rates of unemployment. And, outside of China the rest of the world does share our debt-induced deflationary depression. Germany experienced hyper-inflation because they chose to print money at the worst possible time. We have the ideal circumstances to print money in the U.S. In fact, if we don’t print a lot more money the economy is going to slide a lot lower. There is simply no other way to service all of the global debt. Whereas Germany threw gasoline on an inflationary fire, outside of a few speculative commodities we are desperate to spark inflation in the real economy. There is a time and a place for everything and now is the time to print.
The Fed needs to print enough money that policy makers in Washington will be relieved about worries over the national debt and the federal budget deficit. By taking near term debt worries off the table the Fed can clear the decks for Washington to come forward with a desperately needed massive job focused stimulus bill. There is no longer any reason to quibble about whether the last stimulus bill was adequate to restore economic growth. It is time for President Obama to admit the economy is in worse shape than his economic teams worst case projections. Unless the deficit and defense of the prior stimulus bill comes off the table we will not see a serious jobs bill emerge from Congress. It is up to the Fed to signal all is not well with the economy and to start aggressively buying U.S. Treasury bonds.
Posted by Michael A. Kamperman on October 14, 2009
It may happen as soon as tomorrow. The core rate for CPI includes everything except for volatile food and energy prices. Over the last 12 months the overall CPI rate has declined by 1.5%, primarily due to a pullback in food and energy prices. But for the most part the Core CPI rate has risen slightly month after month despite rampant deflation. Over the last year the CPI has calculated that rents and owner’ equivalent rents (the economist’s substitute for home prices) have risen by an annualized rate of 1.8%. It is mindboggling that the federal government’s statisticians have been using the cost of renting shelter as a substitute for actually buying a house. Everyone knows home prices have dropped dramatically during the last 2 years. The reason the Core CPI rate is about to turn negative is rents are now rapidly falling throughout the U.S. Rent and owner’ equivalent rent combined account for 30% of the overall CPI calculation. Importantly, they account for 40% of the Core CPI calculation. Most economists and investors pay much closer attention to the core rate than to the overall rate due to the volatility of food and energy prices. This summer apartment vacancies reached 7.8%. Landlords are forced to lower prices to attract tenants. Once the Core CPI rate turns negative it will confirm the U.S. is in a deflationary spiral brought on by the credit crisis.
The CPI rate is built into many contracts and negotiations in the U.S. Most employers’ base raises for employees on a cost of living adjustment, plus potentially something extra for merit. With the Core CPI rate trending negative the only raises given to U.S. workers will be for merit. Stagnant and potentially falling wages in the U.S. will only lead to lower prices as consumers and businesses are strapped with excessive debts. They need the forces of inflation to raise their incomes and the prices of their assets to service their debts. This year people on Social Security did not receive their usual annual cost of living raise. Less income will lead to lower top line revenues for businesses. This will mean cost cutting will be the only way maintain or grow profits. In the U.S. cost cutting for businesses is code for more layoffs. Getting out of this deflationary spiral will be very difficult because of the way incomes in the U.S. are tied to the CPI rate.
The Fed is currently pushing on a string and has been unable to get the Zombie banks to increase lending. The only way to fight deflationary expectations is for the Federal Reserve to print a lot more money. Yet some members of the Fed would like to exit their quantitative easing program believing the economy is recovering and inflation is around the corner. These attitudes should change once the Core CPI rate confirms deflation. The good news is the release of minutes from the Federal Reserve’s last meeting showed that some members of the Fed are still open to upping the quantitative easing program.
Posted by Michael A. Kamperman on October 9, 2009
Some Governors at the Fed have recently been speaking out about the need for a rapid exit strategy from the Fed’s accommodative policies. They must think a speculative pop in the markets is equivalent to price stability and economic stability, which are the two things the Fed is charted by Congress to focus on. Is the home listed from a realtor down the street from you in a bidding war? Is your friend from college who has been unemployed for a while inundated with job offers? The American people are suffering. They are unemployed and they cannot sell their home because their mortgage is underwater. The objective of the hawkish Fed governors speaking about the need to have a rapid exit plan is not intended to push for interest rates to be raised in the near term. The comments are intended to push for an end to quantitative easing and the other policies the Fed has put in place to provide extra support to the economy. To date the Fed has done too little, not too much. Consumer credit fell another $12 billion in August despite getting a big boost from auto loans because of the cash for clunkers program. The banks are continuing to tighten credit standards. Auto sales fell back to extremely depressed levels in September as soon as the clunker program ended. Home prices will begin falling again now that the first time home buyers tax credit is no longer driving home sales. How could anyone at the Fed be worried about exit strategies when the real U-6 unemployment rate is 17%.
The hawkish Fed governors are simply too concerned about inflation returning. They see the dollar falling and gold reaching new highs and they assume the markets are signaling significant inflation is just around the corner. Not a chance. Real wages in the last unemployment report rose by only a penny over the preceding month. Hours worked fell to 33.0. Every industry has significant amounts of idle capacity. Inflation comes from too many dollars chasing too few goods. Since over half of the country has a subprime credit score, access to cash to purchase goods is restricted. Since industrial capacity is still way below 80%, there is no shortage of goods in any sector of the economy. Until these dynamics change there is no reason to fear inflation. It doesn’t matter how high gold gets, because the fundamentals of the economy will not support inflation.
What the hawkish Fed Governors should be panicked about is deflation. The fundamentals of the economy point to deflation. In the Great Depression deflation ended in 1933 after FDR declared a bank holiday and created FDIC, which ended the bank runs and brought money out from under the mattresses and back into the banks. He also ended the physical exchange of paper dollars for gold. He ordered the conversion of gold money for $20.67 per ounce in U.S. paper dollars. Then, in January of 1934 FDR devalued the dollar by 40% by raising the gold per ounce conversion rate to $35. We have no such tricks up our sleeve today to end deflation. What we do have to end deflation is quantitative easing. The Fed Governors need to be talking about why they need to print more money rather than how quickly they are prepared to withdraw support for the economy.
Posted by Michael A. Kamperman on August 19, 2009
In today’s New York Times, Warren Buffet wrote an Op-Ed saying that the federal budget deficit was too high in relation to the country’s economy and is unsustainable. He made an excellent point that the world is only in a position to naturally invest about $900 billion per year in U.S. Treasuries from a combination of growing U.S. savings and growing foreign reserve surpluses from our key trading partners. He said that the $1.8 trillion annual budget deficit is twice as much as the readily available capital to finance the debt. He then warns about the dangers of printing money to cover the deficit claiming it will kick off high rates of inflation and says the U.S. doesn’t want to risk becoming a banana republic. He states we risk collapsing the currency if we print too much money, or if we allow our debt to GDP ratio to continue to rapidly climb beyond the 56% ratio it is expected to reach by the end of the year. Warren concedes Japan and Italy have much higher debt to GDP ratios than the U.S. does, but we dare not test the upper limit.
The only problem with Warren’s quaint editorial is the facts do not support his fears. If President Obama follows Buffet’s advice he will plunge the world into economic Armageddon. What will happen to the economy if the federal government stops spending money? Gone will be extended unemployment benefits and support for Medicaid payments to the states. Gone will be much of the defense budget at a time we are fighting on two fronts. Or, gone will be Medicare and Social Security. If we continue to borrow our debt to GDP ratio will grow, as will our interest payments on the debt. But Italy and France have a debt to GDP ratio of over 100%. Germany’s is over 80%. Japan has a debt to GDP ratio of over 200% and has been printing money for years. The British pound has rallied 20% against other currencies in the last 6 months and Britain is printing more money compared to its GDP than any country in the world other than Zimbabwe. Britain also has a debt to GDP ratio over 100%. Yet these are the currencies Mr. Buffet fears the world will flee to. These facts were not part of Mr. Buffet’s Op-Ed.
Compare Mr Buffet’s position with that of Bank of England Governor Mervyn King, who is the equivalent of our Fed Chairman Ben Bernanke. It was just revealed that the normally hawkish Governor King wanted to increase the last round of quantitative easing in Britain by 75 million pounds, rather than by the 50 million pounds the board voted for. The only other times Governor King was voted down he wanted to raise rates more than the committee in both 2005 and 2007. So the question in my mind is what has turned the usually hawkish Governor King in the world’s most dovish central banker? I have a feeling he knows where the bodies are buried and he sees the deflationary spiral the world has entered. One of these men is seeking to lead the world down the wrong economic path. The worshippers of the god of inflation can worship at Mr. Buffet’s altar all they want. But I’m following the path of Governor King. Deflation is the global threat and it is gaining a foot-hold in all of the major economies of the world. In a world without wage pressures, declining demand, and massive excess capacity in every industry, those seeing inflation are seeing a mirage.
Posted by Michael A. Kamperman on August 13, 2009
Don’t ask me because I don’t know the answer. For many years now the U.S. consumer has been the source of final demand and has driven the global economy forward. Because of the collapse of available consumer credit, the U.S. consumer has reigned in their spending as evidenced by today’s disappointing retail sales report. Why some were surprised that rising unemployment and restricted access to credit led to lower retail sales is the real mystery. They explain the aberration in their mind away by guessing that since 200,000 people purchased a clunker in the last week of July that caused 300,000,000 people to close their wallets for the whole month. Who are these people that get passed off to us as experts? Today it was also reported that the Euro-zone economy contracted less than expected and that France and Germany actually had a small amount of positive economic growth in the second quarter. But this growth came from the calculations of modern alchemists known as economists. Because imports dropped faster than exports fell in both countries, the alchemists claim they are now growing. Countries with declining imports are buying less from others because they have weak economies. In no way are they positioned to drive global growth going forward. Many will claim China is prepared to drive global growth forward. China’s has a production oriented economy that is dependent on selling goods to the West. The West is buying less and less. China calculates its economic growth based on production and not based on final demand. So if China builds something nobody wants and sticks it in a warehouse they claim positive growth. If China has such a strong economy why are their imports falling too?
My concerted opinion remains that the key to restoring global economic growth relies heavily on reviving the spendthrift U.S. consumer. With excess debt levels and deflation prevalent in the U.S. and the rest of the world, the only way to restore the U.S. consumer is for the Fed to pursue a much more aggressive policy of quantitative easing. A step they failed to take at yesterday’s meeting. According to the economic data the U.S. economy was still declining in July. The predictions that the recession has ended by some alchemists and the consensus of the alchemists that the U.S. will see positive economic growth in the second half of 2009 looks to be in jeopardy right now. The problem is these alchemists continue to talk about how long past post World War II recessions lasted and base their forecasts on the false assumption that we remain in the inflationary growth economy that defined the first 62 years of the post-war period. Those days ended in August of 2007 and we have returned to a debt-induced deflationary depression.
Fortunately, the Fed with at least three blind mice as voting members did not signal an end to further shots of quantitative easing despite wide spread media reports to the contrary. What the timid Fed did was they punted the ball to the next meeting to make a final decision. Hopefully they can open their eyes and see the economic truth between now and then.
Posted by Michael A. Kamperman on August 11, 2009
The Federal Reserve has a dual mandate; economic growth and price stability. There can be little question that the economy would benefit if the Federal Reserve increased its program of quantitative easing (printing money) at tomorrow’s meeting. But what the markets and the media are missing is that the Federal Reserve needs to print more money to maintain price stability. Price stability requires limiting the amount of inflation or deflation that impacts the purchasing power of a dollar for a domestic U.S. consumer. This should not be confused with whether the value of the dollar is rising or falling versus other currencies like the euro, the pound, or the yen. Printing money to maintain price stability will seem counter-intuitive to most observers of the markets and the economy. The knee-jerk response is usually that if the Fed prints more money we will eventually have hyper-inflation. The Federal Reserve needs to ignore the voices of ignorance at tomorrow’s meeting and follow the lead of the Bank of England and print more money, and lots of it. The reason is the U.S. economy is experiencing levels of deflation that are approaching the levels of deflation last seen in the early 1930’s during the Great Depression. Most people have missed this fact due to the use of owners’ equivalent rent in the CPI index, which dramatically understates the decline in home prices in the U.S.
The official CPI numbers state that prices fell 1.4% in the last 12 months in the U.S. The CPI currently uses owners’ equivalent rent to calculate the price of home ownership. Owner’s equivalent rent accounts for over 23% of the CPI Index. In the last 12 months this calculation has risen 1.9% and has contributed a positive .4% to annual CPI. Say WHAT? That’s right; the official CPI statistics calculate that it is more expensive to purchase a home today than it was 12 months ago in the U.S. An alternative measure of home prices is the Case/Shiller index. This index has fallen over 17% in the last 12 months and much more accurately captures the trend of the costs of purchasing a home for a U.S. consumer. If the CPI used changes in home prices in the CPI index rather than owners’ equivalent rents, then the positive .4% housing contributed to CPI in the last 12 months would actually have been a negative detraction of approximately 3.9%. This means the real rate of deflation in the U.S. over the last 12 months is 5.7%, not 1.4%. If our CPI were reported as minus 5.7% over the last 12 months, then Washington would be much more concerned about deflation.
From 1929 to 1933 the U.S. economy experienced mid single digit deflation for 4 years in a row. But the official CPI Index in the 1930’s used home prices to calculate the cost of purchasing a home for a consumer, not owner’s equivalent rent. The federal government changed the calculation for the cost of homeownership in the CPI Index in January of 1983. We will find out tomorrow if the Fed understands that deflation over the last 12 months is tracking the levels of deflation of the Great Depression. If they get it they will surprise the markets and increase the level of their quantitative easing program. If they don’t get it, then they will stand pat. The Obama Administration has already checked out on further assistance to the economy in the near term. Mr. Bernanke is our last and best hope to battle the economic crisis. My objective in detailing this is not to be value added by helping people understand and interpret the statistics they are looking at. My objective is to give all Americans a wake-up call and say we are facing a New Great Depression and we need to insist Washington takes action.
Posted by Michael A. Kamperman on June 24, 2009
Yesterday, President Obama acknowledged the unemployment rate is likely to exceed 10%. He was asked at his press conference if more action was necessary to boost the economy. He said the stimulus plan still had a ways to run and he wanted to wait and see if the actions taken so far are enough to restore the economy. The Congress is bogged down in energy reform, healthcare reform, and financial regulatory reform and has simply taken its eye off of the economic ball. That has left the Fed as the last line of defense to battle the economic depression. But the Fed has yielded to the bond vigilantes worried about renewed inflation from quantitative easing. The Fed has decided to take no further action at this time and will wait and see how the economy and the markets respond. What is significant about the Fed’s lack of action is their own reading of the economy is inflation is not a threat in the near future and they expect commodity prices to moderate and respond to supply and demand imbalances. Additionally, the Fed does not see an economic recovery taking hold yet. It only sees the rate of economic decline slowing. My biggest complaint is the Fed has gone on hold because it is confused by the trading actions of speculators, not because it anticipates a potential V-shaped recovery and a resurgence of inflation. Washington has now officially signaled this week that they are on the sidelines and are willing to wait and watch before taking further action. Since the President already anticipates a 10% unemployment rate, it is reasonable to assume that a significant impetus for further economic action will have to wait until the unemployment approaches 11%.
If one looks back at the severe U.S. recessions of 1973-1974, 1980-1982, or the milder recessions of 1991 or 2001, then one would see that a V-shaped economic recovery did occur. So my take is Washington doesn’t think it’ different this time. They have bought in to the rhetoric that the risk of a deflationary depression is now off the table. Why? The economic collapse can be traced directly to a crash in the non-government asset-backed securities market that relied upon the credit rating agencies. This market fueled the shadow banking system that was responsible for providing over 70% of the credit needs of the U.S. in recent times. This market remains broken and the commercial banks have not increased lending despite the TARP and the increase of reserves provided by the Federal Reserve.
Perhaps if they got out of Washington and talked to small business people rather than think tank economists they would actually hear what is happening on the ground in this economy. The consumer accounts for 70% of U.S. economic activity. The consumer is facing rising unemployment and still further tightening credit standards. Reports from realtors are that strict new guidelines for appraisals from Fannie Mae and Freddie Mac are killing multiple potential sales transactions. Unfortunately, Washington seems to believe that our economy should rely much more on manufacturing, exports, and consumer savings. The only problem is they have yet to answer the question increase exports to whom? Today, the Swiss government intervened in the currency markets to drive down the value of their currency against the dollar. The world doesn’t want to lose export market share to the U.S. The Fed should have upped its program of quantitative easing today. The President and the Congress should be focused on fixing the broken credit markets before they try to tackle long-term issues such as healthcare reform, energy reform, or financial regulatory reform. Because a lack of further needed action from Washington the possibility of a 1930’s deflationary depression is not only still on the table, it is the probable outcome.
Posted by Michael A. Kamperman on June 11, 2009
First of all modern money is not gold. Gold is a commodity. In ancient times gold was money, but not today. If you don’t believe me just go to the local grocery store and try to buy your cart of goods from the cashier with a measure of gold as payment. However, if you pull out some cash, or write a check, you can acquire the groceries. Similarly, in the vast majority of stores you can pull out the plastic fantastic and if the electronic swipe says transaction approved, then you can walk out of the store with the groceries. What constitutes money is whatever gives you the ability to complete a transaction. It doesn’t matter to the grocer where your money comes from as long as he gets paid. Likewise, when you sell your home you only care if the buyer can show up with the cash to complete the deal. It doesn’t matter to you whether or not the buyer is a cash buyer, or whether he needs a loan. It’s all cash to you. Hence, what constitutes money is whatever enables a buyer to complete a transaction with the vast majority of sellers.
Why this is important is it is relevant to the discussion of whether or not we are on the verge of deflation or renewed inflation. It is imperative the Fed gets this right at their next meeting. Those that look at only cash as money are insisting we are on the verge of hyperinflation. But they miss that credit is money too. For the seller of the house it doesn’t matter where or how the buyer gets the cash. If the buyer can get the cash, then the deal goes through. If the buyer cannot get the cash, then the deal falls apart. Has the Fed increased the monetary base, absolutely. Has it led to inflation, no. The reason is the credit side of the money equation has collapsed. The access to credit is severely constricted everywhere in the world, except China. To illustrate this truth despite the Fed’s printing money the M1 multiplier has fallen almost in half, from an average of 1.6 in 2008 to .86 last month. Transactions are not occurring nearly as frequently as they did in the past. If this continues our fate is deflation, not inflation.
When the Fed meets soon it will be confronted with a market that fears fiscal irresponsibility and pending inflation, maybe even hyper. But it will also face a real world economy where transactions are still slowing because credit is becoming even tighter. For example, the cap rate on commercial real estate transactions in 2007 was 4%, despite a Fed Funds rate of 5.25%. This means that a bank would loan a company 25 times the annual collected rents on a building. Today the cap rate for commercial real estate is 8%, despite the Fed Funds rate being close to 0%. This means a bank will only lend 12.5 times the annual rents collected. It is not enough for Ben Bernanke and his colleagues to have an intellectual knowledge of what to do. They also have to have the chutzpah. The real economy needs massive quantitative easing and the bond vigilantes, like China, call for raising rates and defending the dollar. The Fed needs to lead and not follow.
