Friday, May 29, 2009
Busy Today, But....
As the dollar drops, they must rise. And so must Treasury yields, and therefore mortgages.
So that's another crimp in PCE, because consumers ain't gonna be feeling too good when they see what's about to happen in the stores.
So much for monetary policy. The only thing that would really shortcut this, given that the US ran a 900 billion dollar deficit in the freakin' first quarter of 2009, would be another massive global shock. I certainly hope we are not about to get one.
In the meantime, we can all feel good about the fact that the US dollar is still preferred to Argentina's peso.
Even US domestic investors with major stakes in the country are going to try to invest their money abroad. So what's going to boost gross private domestic investment? And if that doesn't go up, no real recovery!
This is what happens when you try to futz the market. It rebels. And when you make the rounds trying to establish an international framework that makes it difficult for US companies and individuals to move funds outside the country, you inspire angst, and a sudden desire to figure out what's possible in terms of fluidity.
Update: Tim Duy with a very long article discussing some of the dynamics:
In essence, the Fed's ZIRP policy combined with stable financial markets once again makes the Dollar carry trade attractive. Since old habits die hard, this should "force" foreign central banks to accumulate Treasury assets - and it has.The important point Duy makes later on (in his long list) is that the US is dependent on capital inflows. It sure is. And that means that if you have a set of monetary and political policies that make it hard to earn money in US dollars, or impossible to both earn and repatriate, you drive the dollar down. Duy goes on:
It is almost as if foreign central banks know that the endgame of everyone's behavior is inflation, and thus avoid longer dated securities. Not a particularly comforting thought - but one consistent with the steady rise in the 10 year Treasury-TIPS breakeven spread.
US labor market weakness appears inconsistent with a sustainable inflation dynamic; thus, rising oil prices simply cut into domestic demand. Thus, the Fed will be inclined to hold policy steady, rather than exacerbating oil driven weakness by tightening. Tightening policy would also reverse the evolving stability in financial markets and threaten a new credit crunch. And given the Fed's willingness to accept a benign view of the yield increase, they are not likely to increase Treasury purchases. Policy on hold. This may again have the side effect of putting relentless downward pressure on the Dollar. This is probably necessary to achieve further rebalancing of economic activity, but I suspect in the near term it will be disruptive. Alternatively, the dynamic could be reversed again by a new crisis that drove flows back to Dollars. There may be so much directionless liquidity flowing through the global financial system that it just starts constantly shifting here and there, looking for a home.That is a wonderful description of what appears to be happening. First, the weaker the US dollar becomes, the higher oil and other commodities go, and the weaker domestic US spending becomes. But this is not an endless process, because eventually the rise in oil forces more money into dollars, thus swinging the pendulum back.
The problem here is not just the US deficit - it is the US trying to write mortgages at way below market rates with the coinciding need to shove 1.5 trillion dollars worth of yucky, unattractive debt somewhere. The US can continue to buy mortgages only as long as it can sell Treasuries at low enough rates to cover the eventual losses as well as the servicing expenses. But foreign, especially Asian, countries had until recently been buying a lot of agency paper and recycling dollars that way.
So if the Fed lets long Treasury rates rise, mortgage rates must rise, which will choke off US house price gains. Also, the cost of servicing the US federal deficit will shoot through the roof. That will leave Treasury with the option of printing money to buy Treasuries, or induce the need to massively raise taxes.
The solution is the opposite of what current US policy now is, because US current policy is focused not on saving the economy, but on saving banks. The US should let US agency paper rise until the market wants it. This will further push home prices down, but it will cause US domestic home demand to jump because there are a lot of people with money sitting and waiting for home prices to drop enough to make it worth their while to buy homes with their cash. As prices drop, their cash contribution is relatively more of the home price, and so the rise in interest rates means less to these potential buyers. This would break some US internal money out of its sitting cycle, and increase domestic velocity.
It would also attract external money as a capital inflow into the US. You may think that foreigners won't buy this debt, but they will if it is the right risk at the right price. I'd love to buy mortgage passthroughs in USD with weighted average CLTVs of 60% at 6.75%, or weighted average CLTVs of 70% at 7.5%. Anyone who looks at some of the Asian exchanges must see that the infusion of money is producing some real valuation oddities, and I am willing to guess that quite a bit of that money would jump in the boat with me.
As it is now, buying oil futures contracts are a great way to hedge losses against the decline of the USD, and there are an awful lot of interests which need to hedge against USD losses because of pre-existing exposures, which tends to suggest that oil buying will not end until oil prices rise enough to induce another round of global contraction.
So I don't think stagflation covers this situation. I think a more appropriate term would be negflation, in which negative growth is joined at the hip with rising fundamental costs which induce inflationary pressures on the spending power of consumers sufficient to reinforce negative growth.
Since turning bearish in 2004, I've felt that we we combining the deflationary Great Depression with the inflationary 1970s. I did not think two wrongs would make a right.
I've been riding much of this out in TIPS and I-Bonds, hence my stagfationary name. I have also stated that even if I didn't get the inflation vs. deflation argument right, I was pretty sure I had the lack of growth idea pegged. TIPS do great during inflation and low growth, but can do okay with just one of the two.
I never felt comfortable with Deflationary Mark long-term and if I was a pure stagflationist I'd own oil. I think you really hit the nail on the head. My name should have been Negflationary Mark. I'm a believer!
I also offer supporting evidence that the government agrees with you. I-Bonds were a great Negflation investment. They can't drop in price during deflationary crashes. They rise in price during inflationary episodes. They are also tax deferred for up to 30 years and they are very liquid.
Is it any wonder that the government reduced the amount of I-Bonds we can buy from $30k to $5k per year (in paper and electronic forms) and set the rate to just 0.1% above inflation?
Can't be any more succinct than that. Great job, MoM!
Another topic- I just read The One took Churchill's bust out of the Oval Office. It might of offended the Palestinian Terrorist, I guess. Somebody shoot me.
Good point. I think a lot of mischief has been done by the use of the words "inflation" and "deflation". I suspect those two words cover a multitude of unique conditions, more properly described by unique words.
That said, I'm still not sure how to accurately describe the contemporary oscillatory monetary and commodity inflation/deflation. Monetary inflation leads to commodity inflation leads to deflationary wealth destruction leads to monetary inflation. I'm not sure what word adequately captures the see-saw dynamic quality.
Grantham of GMO turned moderately bullish on the market and thinks that the stimulus will have some effect, guaranteed at some. What are your thoughs on the stimulus coming into the pipeline ???
"And then they wondered why the next flight of the Fed Inflation Hawk did not inspire confidence!"
It could be worse I suppose. They could use Mankiw's solution. You know, randomly destroy 10% of our legal tender as a way to get us to spend the rest. What really gets me is that Mankiw thinks that the remaining 90% would still be worth 90%. Not a thought of the unintended consequences of confidence destruction.
He's clearly never had a prey animal as a pet. Flee first, ask questions later.
For example, see this article about the King Cty stimulus:
The Seattle-King County Workforce Development Council received $8.5 million in total stimulus money from different pots, made up of $3.1 million for youth, $4.1 for dislocated workers and $1.3 million for adults.Sounds good, except one questions the adult/youth breakdown. But then these details gave me pause:
Of the $3.1 million going to King County and Seattle, $1.2 million goes to the youth for wages and other compensation, which could include bus tickets, uniforms or equipment.. That figure translates to $1,400 in compensation per person. The youth earn minimum wage.
The rest pays for coordinators to take care of the internship details and paperwork so that hiring employers do not have to.How much of the money is really getting through to the street level? In this case, not one third is actually getting through to kids. The rest is really being used to support non-profit employment. The diffusion index on a lot of the stimulus appears to me to be incredibly poor.
It appears to me that the government contract money is getting out there, and is being used to support government employment. Otherwise, not much is hitting the streets.
What bothers me is the increase in oil and gasoline prices. Especially when MOM cites statistics that show supplies are not tight. Is that market being gamed again? If gasoline gets back above $3/gal. it will begin to cool whatever economic stimulus there is. So the recovery may die a premature death, snared on the horns of Obama's energy policies.
My prescription for recovery would be drill, drill, drill (as Kudlow says) smooth the way for nuclear power plants to be built, cut corporate taxes(to create jobs, jobs, jobs), and cut out the social spending. (The Obama budget is loaded with it.) Fat chance any of that will happen.
As far as investment plans. This bull has some energy left, but energy and commodities prices are going to sap that. Gold, Canadian loonies, and commodities are the place to be for now. But that trend won't last either. Nimbleness and adaptability will pay dividends.
Oh yeah, "Don't cry for me Argentina."
Most of the analysts I read are noting that bearish sentiment has made it safe and likely profitable to go long oil as a hedge against inflation. It seems we're going to get a rally in oil, based on deficit fears. I have no idea how high it can go--I don't think it can get as high as it did in 2008 without causing disaster.
I suspect that at some price, higher oil prices become a negative feedback cycle with interest rates. In other words, oil goes up, leading to fears of prolonged recession and lower tax receipts, which leads to higher treasury rates and a bigger interest payment on Treasury debt due to greater fears of default, which leads to a weaker dollar, which leads to higher oil prices, which....
In a sense, I suppose that is a game, as it is speculation on the future. But the fears are real enough.
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