Tuesday, August 31, 2010
Why Monetary Stimulus Is Needed
Chicago PMI: Under the circumstances, this is a very strong report. It shows slowing activity but also continued growth at a nice level that should tend to provide some bottom-level push up in the economy. The headline was 56.7 (aggregate indicator). That is well above the 40 year median, although this month production did drop below the median. Order backlogs and employment are way above the median, which suggests continued health for months. Prices paid are well below the median, although some of the comments received suggest that manufacturing will be price-sensitive as well.
And that is good, because the bid/cover on four week T-bills was 4.02, on three month T-bills it was a staggering 4.95, and on six month bills it was 4.18. And you know what that means - it means that buying is concentrated on end-of-quarter and end-of-year needs, and probably a lot of the buying is from banks. Maybe a lot of demand overseas. German bunds are hot also, and the rising yields for the riskier European stuff certainly might make European banks buy the stables. But to the extent that it is domestic, it certainly implies that banks will tend to be pulling money out of the economy rather than inserting money into the economy.
State Street's investor confidence survey fell again. The Conference Board's consumer confidence index showed an uptick from July, but is still at 53.5, which is not only very low historically, but is in fact below the year-ago level. The current situation assessment as 24.9 fell significantly from July's 26.4. Again, these levels demonstrate both price concerns and employment concerns. The future expectations are all that is holding this thing up, and the problem is that those expectations will be modified by experience.
Again, the negative assessment of current conditions is concerning given gas prices. See TWIP (This Week In Petroleum). Current gas prices are near year-over-year parity, and diesel is not up that much YoY. Stocks of finished product are running extremely high, though, except for propane which is solidly in the middle of the average range. And crude stocks continue well above the average range. There is very little pricing support for this market, but refining margins are quite restrained. See the two pump graphs at the right on this page.
The grocery business is suffering an extremely tight pricing environment. This is pretty much the case everywhere except for extreme high-end. I direct you to Lempert's commentary on the spread between retail food prices and wholesale food prices. And this brings me to a fact which did not escape the attention of Brian Horey of Aurelian Management. I like Brian, because he literally sits down and goes through the reports and the financials.
The minute the GDP update came out, Brian emailed me about food's second quarter performance in GDP, which was, you guessed, negative. In fact, in real terms, food expenditures fell 5.7% (see Table 3 on page 7) And this brings us back to the first link in the paragraph above, which is about Winn-Dixie's 5.2% same-store sales drop. Winn-Dixie is really outperforming! Now, almost always such an indication will either correct of its own or, if it cannot correct, will produce a hard contraction within a year or two. Unfortunately the BEA doesn't report much in the way of the differences I track, but it is easy to see from the detailed NIPA tables how close a correspondence between the economy and food sales there is.
Okay, you knew you weren't going to escape the graphs. These are percent changes for GDP and the food purchased for off-premises consumption.
Chained Dollar, Recent:
Current dollar, recent:
Current dollar, the long view:
Based on food alone, we have entered the next contraction. Normally freight and so forth would have to correspond, but the truth is that we are not in a normal period. We are in a depression-like period. Anyway, this is what Who Struck John (it was reality that whapped him, apparently), who is in the food business, has been seeing and recounting to us.
Now, usually a substantial period of declines in the slopes for food will predict a recession. Sometimes that will be offset by another environmental economic change, such as monetary/rate stimulus, which produces a favorable cycle by shoving more money into people's pockets with which to buy food.
Or, as in 2005, people can just respond by borrowing tons of money. But obviously the ability to keep borrowing is limited, so sooner or later that catches up with you.
And this is the explanation for why I had to hit Barro with a club yesterday. An economics which is not concerned with the fact that the population is having trouble feeding itself is an idiotic economics doomed to fail. The reason why food sales dropped on a nominal basis in Q2 was that many people lost their unemployment benefits, and the jobs weren't there to replace incomes.
It will be difficult to craft policy responses sufficient to overcome this, although the recent extension of both the qualification dates for the tiers and the qualification dates for the initial unemployment (gets you on the ladder) will help.
Next we go back to monetary stimulus, hopefully with a bit of reality imprinted in our brains. I am not even going to take up Kocherlakota's speech, which Saloner described accurately as "Another genius that misses the economic wood for the mathematical tree."
May be the biggest is: end corporate income tax ( as Fred Smith ( FedEX ) has pointed out, the US tax code is particularly punitive for capital intensive industries ). Also, end taxes on all forms of private saving and investment, establish a rigorous cost-benefit basis for all regulation across the economy, end labor monopolies, improve human capital by reforming k-12 education .
These changes would make the US a more profitable, and hence more attractive destination for foreign and domestic capital, and would improve the quality of workers in the workforce.
Depending on demand management, in whatever form, to lower unemployment is to pursue a course that has repeatedly failed, and in any event, has proven to be highly political in its implementation. And, median income has been stagnant for years, regardless of the unemployment rate.
What's bad is if people begin to suspect that the U.S. is not going to do anything about the deficit--that is, that not only is the Fed is going to print money to buy debt, but that the Congress is going to print debt to buy votes. If Congress were to reduce spending, I think that would reassure people that we're not planning on pulling an Argentina, and the dollar will remain a good store of value. In that case, the Fed is free to meet the demand for dollars by purchasing Treasury debt--essentially extinguishing it, for practical purposes. As surely as the Social Security "lockbox" never existed, that debt could be declared extinct. This has the added bonus of forcing returns-seeking investors to purchase private debt instruments, to contribute to productive capital. Et voila! We're paying down the debt. Eventually, even the Chinese and Japanese holdings would be paid down.
Of course, the prerequisite is, again, to reassure investors that we're not just going to have the Fed print money to pay last week's doctor's bills, that we're going to get the budget under control sometime in the next few years. If people begin to doubt that, it's all over.
Make labor cheaper with the elimination of the
payroll tax. Make foreign labor more expensive with tariffs on finished goods. The tariff funds can be used to cover the loss of the payroll tax. God forbid we
help those on the bottom end with jobs. What good is world trade when we go broke trading ? Would China
trade places with us ? No.
I look forward to your post comprehensively listing the monetary actions you regard as critical.
But there's one issue that ceaselessly troubles me with regard to the response, so far, to the situation:
I haven't seen one credible plan addressing the resolution of the bad debt losses that, in my view, are the prime cause of the current woes.
The trick, in my view, is to manage the write-downs in a fashion as to not abruptly bring the roof down.
Policies so far, it seems to me, are premised on the hope that once growth gets going the bad debts will quickly, and automatically, plunge to manageable levels.
I'm not sure reality, currently, is favourable to such hopes.
At these prices I told my wife she is absolutely not to buy b-fast cereal or anything processed & frozen (except a little juice). Does that mean I'm part of the problem or part of the solution? Seriously.
I worry this is going to catch up at some point once herds are thinned. Anyone know if that is actually the case, beef herds being reduced? (I've been debating buying a deep freezer.)
Whole, wild-caught salmon has also been $5/lb most of the summer. Not really a fair trade-off as we eat at best 1 fish a month.
All in all, meat has been a great bargain, but everything else no big deal. (Which also makes me think it's herd sizes being reduced.)
I'm not sure where this will stabilize. Supposedly most the herds were already cut down.
Groceries are competing hard for business unless they have quasi-monopolies in an area.
First, most teenagers are still quite used to living at home, without high overhead. If they go another year without a full time job, they don't really care.
Whereas a worker that has had a job and now has obligations will try much harder to find work.
Secondly, and much more importantly. Where is this money coming from? Have we suddenly created a new entitlement that people will get paid forever? We already have food stamps and numerous safety nets. The I in UI is for insurance. Once we just start tapping the treasury and borrowing money to give to people, we are skewing the financial and job market and digging a much deeper hole for all of us.
When Obama signed the last "extension" he was proud that the woman next to him wouldn't have to go to her father for financial help.
Well, if people did have to scale back, sell some stuff, depend on family, etc., the people might rise up and demand more than these piecemeal extension. Like an atmosphere where business can flourish.
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