Fed Watch: Not a Pretty Picture

Tim Duy is worried:

Not a Pretty Picture, by Tim Duy: It is simply delusional to deny the impact of surging inflation on household spending. The April reading on consumer confidence pegs year-ahead inflation expectations at 4.8%, up from 3.4% just three months earlier in January and the highest since 1990. This is not good. True, the Fed can take comfort in the fact that long-term expectations continue to hover around 3%, but I would not become to complacent on that front. If the Fed continues to pursue policy that confirms agents near term inflation expectations, longer term expectations will rise accordingly. That would leave the weak job market as the last defense against a fundamental shift in the inflation regime. Let’s hope it won’t come to that.

Of course, the Fed sees inflation – it is all over the most recent minutes:

Real disposable personal income was unchanged in the fourth quarter, held down by higher food and energy prices, and moved up only slightly in January…

Household survey measures of expectations for year-ahead inflation jumped in March to their highest levels in about two years; in contrast, survey measures of longer-term inflation expectations were unchanged or up slightly…

Payroll employment declined substantially; oil prices surged again, crimping real household incomes; and measures of consumer and business sentiment deteriorated sharply.

Honestly, it is tough to justify the Fed’s continue description of inflation as merely “elevated” given their own descriptions of inflation in the minutes. And note the Fed remains hesitant to recognize its role in fostering higher inflation. They come close on at least one front:

Agricultural prices were rising at a substantial clip, partly in response to strong global demand, lean supplies, and a lower foreign exchange value of the dollar… the recent depreciation of the dollar could boost import prices and thus contribute to higher inflation.

They accept  the inflationary consequences of a weaker Dollar, including the link to agricultural prices (and, presumably, energy prices). They then take comfort in the “anticipated … flattening of oil and other commodity prices,” seeming to ignore that their policy stance has something to do with the Dollar. Still, one cannot imagine that they do recognize this link. If so, they leave a pretty clear trail of breadcrumbs between their policy and recent “elevated” inflation rates – a clear enough trail that one would think they would be more cautious about pace of easing (or additional easing at all).

Interestingly, the sagging Dollar clearly elicited a stronger response from the G7 in this weekend’s communiqué, giving hope that the Fed is becoming more aware of the full implications of their policy stance:

Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability.

Presumably, both Fed Chairman Ben Bernanake and US Treasury Secretary Henry Paulson signed off on this language. So it is reasonable to conclude that the Fed is starting to get just a bit more concerned that their policy choices are having some unintended consequences. Of course, if the G7 was really concerned about exchange rate stability, they would put more effort into coordinating monetary policy than jawboning currency traders. Instead, G7 policymakers must realize the current state of affairs will continue (it is their decision, after all), particularly the policy gulf between the Fed and the ECB. Which means they expect ongoing pressure on Dollar, enough pressure to elicit stronger jawboning from the G7.

I anticipate jawboning will have its expected impact, at least initially, including a hit to commodities. When the novelty wears off, will the G7 resort to the more forceful tool of coordinated intervention? I honestly hope this does not devolve into an episode of the Fed easing policy on one hand and then intervening to support the Dollar with the other hand. I find those situations to be emotionally draining – like watching a friend in a self destructive pattern but being unable to help.

I fully appreciate the current policy dilemma Bernanke & Co. face – this is not your garden variety Keynesian slowdown. The yawning current account deficit represents consumption in excess of productive capabilities, and we are resolving that imbalance. The resolution entails accepting some moderation of domestic demand in concert with expansion of external demand that will be consistent with a new constellation of interest rates, exchange rates, and prices. It is not obvious, a priori, that we know the monetary policy consistent with that new equilibrium. But policymakers should realize that implications of that adjustment when setting policy.

My concern remains that the Fed has panicked in setting a rate policy that treats the external sector – and therefore, the current account adjustment – as a mere curiosity, giving little thought to their role in supporting the adjustment. In effect, policy, both monetary and fiscal, has degraded into an effort to dig the economy out of a hole by shoveling deeper. We built the most recent expansion on the back of debt financing, driving consumption gains while real median incomes stagnated on the theory that you can borrow your way to prosperity.  That theory has proven ill-advised at best; the inability to continuously fuel the borrowing binge through housing provided the initial blow to the consumer. The second blow was the softening job market due to the first blow. The third blow was the inflation driven by the policy response designed to minimize the impact of the first two blows. The question now is: does the Fed read the increased pain of consumers as a reason to cut rates 50bp at the next outing of the FOMC? I hope not – but I cannot rule it out.

Then again – perhaps we are simply at the point where inflation is the only politically palatable option. The Bear Sterns rescue is the basis for a massive, fully monetized bailout of the financial sector…and Congress and the next President would oblige. If that is where we are headed, somebody needs to start thinking about capital controls before the rest of the world realizes the US intends to repay its obligations with very devalued Dollars.

Bottom Line: As has been the case for months, I would be much less concerned about the path of monetary policy in the absence of rapidly increasing commodity prices and a declining Dollar. I do not believe it is advisable to let the Dollar completely disintegrate. And given the increasingly clear link between monetary policy, the Dollar, and commodity prices, the Fed would be best to served to moderate the pace of easing. I think they understand this, but I remain worried that fundamentally, they only have one tool, and they will feel a need to keep using it if only to look like they are doing something. This is especially worrisome given that low interest rates are apparently not providing much of a fix for Wall Street – for that, the Fed needs to focus on reducing counterparty risk.

Comments

[esb]

Tim Duy:

"...capital controls..."

Wow.

I perceive that you are truly frightened.

You are in good company.

Just about everyone else is too.

The USA built an economic system dependent on inflation accompanied by the illusion of price stability.

That game has ended,

and what follows is, well, anybody's guess.

[a]

Tim is right.

[Spectator]

Yes, we can expect inflation to be the policy, and likely unstated. Most people have no idea how destructive such a policy is to the fabric of society. Economists will glibly acquiesce to such a policy. Keynes would probably be of no help either, but he did capture the evils of inflation quite well.

"Lenin is said to have said the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equality equity in the existing distribution of wealth.... As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to become almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

[Spectator]

Doug Noland's latest has another clear indictment of the Fed, and its clear violation of sound central banking. Still a mystery how economists can defend Fed policy leading up to this crisis.

"It was a policymaking regime destined for failure. Go back and read some of the speeches by ECB officials - Bundesbank and ECB executive Otmar Issing, in particular. It has been for awhile somewhat a battle of central banking philosophies- the well-grounded and traditionalist ECB vs. the “New Age” Greenspan Fed. The ECB is clearly the victor, with “euroland” citizens (with their valuable euros) winning in the process.

Excerpting from Dr. Issing’s February 2004 Wall Street Journal op-ed piece (highlighted in the 2/19/2004 CBB, “Issing v. Greenspan”): “Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy. Not every strong decline in asset prices causes deflation, but all major deflations in the world were related to a sudden, continuing and substantial fall in values of assets. The consequences for banks, companies and households can be tremendous… Prevention is the best way to minimize costs for society from a longer-term perspective. Central banks are confronted with this responsibility, but there is no easy answer to this challenge. So far, only some tentative conclusions can be drawn. First, in their communication, central banks should certainly avoid contributing to unsustainable collective euphoria and might even signal concerns about developments in the valuation of assets. Second, the argument that monetary policy should consider a rather long horizon is strengthened by the need to take into account movements of asset prices. Finally, it should not be overlooked that most exceptional increases in prices for stocks and real estate in history were accompanied by strong expansions of money and/or credit. Just as consumer-price inflation is often described as a situation of ‘too much money chasing too few goods,’ asset-price inflation could similarly be characterized as ‘too much money chasing too few assets.’”

This was the focal point of an historic debate. Dr. Issing and the ECB had history and sound analysis firmly on their side. The Fed had hope. And I do believe that as runaway Credit excess and asset Bubbles gained only further momentum – and as the consequences of dealing with these Bubbles became increasingly more problematic for our central bankers, the financial sector, and real economy – the Greenspan Fed became only more intransigent with respect to their flawed doctrine. They would not act; Wall Street knew they would not take the punch bowl away; and the Credit Bubble’s “terminal phase” was let to run its own fateful course. While decisions at the Fed may have been made “professionally,” they were nonetheless made from a deeply flawed analytical framework with predictable results. "

[hari]

For God's sake don't be ridiculous inflation is now a lesser evil than 1929 Depression. It may take +18mths or so to rebound; systemic calculous doesn't imply market failure - and with a bit of hidebound tightening things will look rosier before its get real bleak, I suspect. Monetary measures take time to impact the market, and fiscal stimulus however small is underway....

[a]

"For God's sake don't be ridiculous inflation is now a lesser evil than 1929 Depression."

Yes but is 1920s-Germany-style hyperinflation a lesser evil than 1929 Depression ? I'm just amazed at the number of people who think both that: (1) a Great Depression is possible; and (2) while possible, it can be avoided by a little tinkering around the edges.

[paine]

tim duy
doesn't get anything right enough here
to be worthy of reading

his cry inflation is rising inflation is rising

refuses to watch the trend in nominal wages

which to his surprise apparently the long rate markets do notice

he has no clear picture to draw on the forex front

the g7 is the whole external sector ??

"not your garden variety Keynesian slowdown"
gets it precisely wrong
this is lkeynesian and its not a slow down

macro policy
can't "handle " this situation
with managing credit flows alone
ie its a very classic kenynesian ....crisis

a braking down has begun
right there
in the pri sec's interface
between
the hi fi and the " real " economy

the hook ups aren't functioning effectively

interest rates paid by corporations
can be ignored

fiscal deficits need to expand dramatically
say to 10% of gdp
while the dollar continues its swan dive

here is the contradiction
a new deal paradigm
is the order of the day domestically
ie an inward only looking US macro policy
BUT an every nation for himself regime
ie chaos must be avoided internationally

possible to square these to conflicting objectives ???

well not by joining the tim duy befuddlement

the " why don't one tool fit all " befuddlement

[paine]

"Yes but is 1920s-Germany-style hyperinflation
a lesser evil than 1929 Depression ?"

if you can ask that question with a straight face

you need to do some reading up
on the two subjects

"The USA built an economic system dependent on inflation accompanied by the illusion of price stability."

the notion of a policy produced
"delayed price surge "
implied here

---to make the senttence coherent---

could use some explication

"Most people have no idea how destructive such a policy
---inflation ---
is to the fabric of society."

perhaps that's because
most people are not
living off
forever fixed nominal money streams
and from that fact draw fairly sensible
conclusions

most anti inflation hysterics
are either self serving -- "bond holder" horse feathers--
or the endemic product
of 100 years of bond holder agitprop

[Jeff]

Obviously the FED understands what its actions are doing here.

The US economy is dependent on asset prices rather than productive activity, so a new bubble needs to be inflated to continue the illusion of "growth." The loose FED policies are aimed at blowing the next bubble, but of course the actual form of the bubble can't be dictated.

The market has chosen commodities this time. However, unlike the tech/dot.com bubble and the housing bubble, the current "boom" is going to drag down poor people around the world, and may cause a lot of political upheaval. And that's while it's inflating. The damage when it pops could be even bigger if it's allowed to keep growing.

[paine]

spectator
your quote on the terrors of inflation
reads more like herb stein
then jm keynes

if keynes wrote this
and i have no reason to doubt it
-----since i've seen it quoted
with the frequency of an urban legend ---

all decked out in bells and curled toe slippers
as it is

with its peppering of lenin
and its col. blimpish lingo ...
" debauch the currency"

he must have been talking
---as was his several sided way---
out of the ladies garden club
side of his mouth

these are not his deeper thoughts here
thoughts produced
with his best blend of logic and imagination
and they were produced if produced by him at all
like grand ma's bonnet
to conceal his ultimate intentions

this is not keynes giving council
to a closed meeting of the policy elite

this is not keynes
as oracle
placing his deep insights
at the service of public weal

[paine]

"sound central banking"
means
at the cross roads of decision
"debauch the people not the currency " eh ??

[paine]

"Just as consumer-price inflation is often described as a situation of ‘too much money chasing too few goods,’ asset-price inflation could similarly be characterized as ‘too much money chasing too few assets.’”

that "cleveration"
gets itself into more confounding of the subject
and compounding of the problem than its worth

product and asset markets bare
not even second cousin level similarity

to say asset price spirals are credit policy creatures
is not to say its all about
a too much of anything
chasing
a too few of everything else

spec spirals like wage price spirals
are sustained by credit policy not induced by them

a monetized fiscal expenditure
that continues past the point of full capacity utilization
is a proper candidate for the too much too few maxim

not any of the set ups we face today
outside say

zimbabwe

[Fullcarry]

Pain you protest too much.

[Such a Deal]

Higher inflation, and lower interest rates. Somehow, this does not seem like a recipe designed to entice foreign savers to loan mortgage money to citizens. The last high inflation period convinced domestic savers not to loan any more money to their fellow citizens. The coming inflation may wind up doing the same for foreign savers.

Domestic borrowers want to borrow, and not pay it all back. Its tough to find someone who will go for the other end of this deal. Ponzi like schemes can keep it going for awhile, but such schemes are necessarily finite in nature.

[paine]

fullcarry
quite the contrary
when it comes to inflation
i protest very little

price lifts are easy adjustments
compared to real output drops

to me
its the intentional jobicide induced by macro policy
that i protest
to me un necessary destroying
of existing jobs
and aborting the creation of new jobs
in the name of sound banking

that is a crime against humanity

[ken melvin]

Did wages ever cause inflation?

[paine]

"foreign savers"

no these
are trade credits backed by
the fed's dollar mine

but paine
when this paper
comes do
it will be paid back in cheaper dollars

all the better to hide just how low ball
the low ball price is my dear

[paine]

"Did wages ever cause inflation?"

now that is a real serious question

was the dynamic caused by
wages trying to catch up with
the full revenue product of jobsters labor
or the profit margineers
attempt to retain the producers surplus gap
as corporate earnings

either way

the process was "validated " by credit policy

its not that
nominal increases were passed thru without any real
consequence
it was the ever more hideous muddle
of policy combinations
we got in the low 70's
part validation part stymie

says...

I suggest those who are unable to entertain inflation as a lesser evil - go to interview with *Dr Doom* (Henry Kaufman)
in todays Links. He was one of the pioneers, I recall, during 1970s oil based inflation which sky-rocketted + Fed rates in double digit. He has also written about the subject.
Moreover, he's demanding a *global* approach to regulatory controls by professionals (not political hacks, as I called them). The crisis is not comparable to 1970 debacle when OPEC
oil prices quadrupled....Dr Doom considers Fed actions are not adequate because foreclosures are going to affect the middle-class and that will reverberate thru the economy.

[hari]

Above is me, *hari* - not *says*. I don't know how ursurbed my post....

[hari]

Above is me, *hari* - not *says*. I don't know how he ursurbed my post....

[hari]

I suggest those who are unable to entertain inflation as a lesser evil - go to interview with *Dr Doom* (Henry Kaufman)
in todays Links. He was one of the pioneers, I recall, during 1970s oil based inflation which sky-rocketted + Fed rates in double digit. He has also written about the subject.
Moreover, he's demanding a *global* approach to regulatory controls by professionals (not political hacks, as I called them). The crisis is not comparable to 1970 debacle when OPEC
oil prices quadrupled....Dr Doom considers Fed actions are not adequate because foreclosures are going to affect the middle-class and that will reverberate thru the economy.

[Overblown]

Oh for goodness sake. The Great Depression has been used as a justification for every mad inflationary scheme over the last several decades. The unemployment rate is only 5%, and the GDP is steady. We are not in a Great Depression, and don't need high inflation just to try and drive the unemployment rate down another 1/10 of 1%. It is not possible to calculate the natural rate of unemployment with that degree of precision. Enough already.

[Spectator]

"For God's sake don't be ridiculous inflation is now a lesser evil than 1929 Depression."

So now that's what we're left with due to the inflationary policies we've pursued? Yeah, we should continue the path we've been on, with no recognition of the cause of the problem. When should an addict acknowledge the need to and voluntarily take some pain? Mises has spelled out the choice - but perhaps we can postpone the problem long enough to wash our hands off it.

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

[paine]

overblown...
i love you

"The unemployment rate is only 5%, and the GDP is steady. We are not in a Great Depression,"

agreed

" don't need high inflation just to try and drive the unemployment rate down another 1/10 of 1%. "

agreed
but we ought to drive it down to a pure frictional rate
and keep it there
and getting there and staying there
will cause a price spiral
unless we
throw together
a price setting co ordination system

a new improved nira

"It is not possible to calculate the natural rate of unemployment with that degree of precision."

you're right ...because its a figment
of a bunch of x class
hired ideologues
clever concoctions

[paine]

" .. no recognition of the cause of the problem"

that phrase by itself
applies quite handsomely to yourself
herr spec

you might try draining
the mental swamps
you've sunk
your fixed set of alpine memes into

its like the ancient monocausal
explanation of the demise
of native hegemony
here in north america

"fire water"

[Overblown]

"...we ought to drive it down to a pure frictional rate..."

If you have a method of reducing unemployment to near zero without reducing the standard of living via inflation, I'm all for it. Everyone who wants to work should have a job. I'm just fed up with the alarmist claims that without constant inflation the nation will sink into another Great Depression.

[paine]

"I'm just fed up with the alarmist claims that without constant inflation the nation will sink into another Great Depression."

over blown
i knew you were
a right on cat

the "we got no choice but to take it
in the ..."

is the product of hobson's choice framing
of macro policy
that has been 60 years in the making

re -imposed state passivity
is the result

its as if the medical community
got us to renounce anti biotics
and return to blood letting

[don]

Overblown, I'm with you. And Tim makes a good point that we are trying to maintain borrowing to prevent a slowdown, even though we are currently borrowing at an unsustainable rate. Unless we reduce borrowing, we must come to a point of real reckoning, and there will be no easy way out then. The Fed seems to be trading on its inflation-fighting credentials, but people will catch on to such nonsense as the use of 'core inflation excluding food and energy' and forecasts of oil at $70 a barrel. That would come only if they stopped supporting global demand through unsustainable U.S. borrowing. Once that credibility is gone, the ability to get a little more output by accepting more inflation will disappear - more inflation will yield nothing but spiraling expectations.

One of the problems is that no one wants to take any medicine. The EU doesn't want inflation, so they won't lower interest rates, but they don't want a slowdown, so they don't want further dollar depreciation. The Fed seemingly can't take even the most modest short-term slowdown, so it wants to keep up U.S. demand by maintaining U.S. borrowing, even though U.S. demand is already too high and creating an ever-greater U.S. foreign debt. Asian countries want to maintain growth, which is based on trade surpluses, so they have kept their currencies at artificially low levels. (Not just the yuan - the yen is also too low and is at all-time lows against the euro.) Something will have to give. Obama and Clinton have started to remark on China. It is about time.

If there is intervention to support the dollar, that is fine - it is too high relative to the euro. But it is too low compared to the yuan and the yen, so across-the-board dollar appreciation is not a good answer. Asia must take its share of the slowdown.

[Lafayette]

More stupid

Article: I anticipate jawboning will have its expected impact, at least initially, including a hit to commodities.

Jawboning will have an illusory and transient effect. Only dollar purchases by the ECB (perhaps China added) will make the dollar appreciate. But, will it be sustained? Probably not, so why do it? Only fundamental long-term reforms can affect long-term dollar rates. Why?

Because of Uncle Sam's chronic deficit. For as long as the US does not put its profligate finances in order, then it cannot expect either the Europeans of the Chinese to bail it out.

Remember Vice-Lead-head when he said that Nixon "proved the deficit didn't matter"? More stupid than that signals terminal brain damage. Anyway, they've all become the walking dead in this badministration.