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Thursday, November 04, 2010

First, The Scaling

I was somewhat astounded yesterday to read Neil's comment:
That's $600B dribbled out over the next 8 or 9 months, which will probably go straight into commodities, like you say. I understand how energy would be a problem, but it seems more likely that the flows would be concentrated in the precious metals complex, given the way that market looks. If the asset inflation is concentrated in PM's, will this QE actually be a big enough to raise the price of consumer staples appreciably?
Objectively, this is a huge number. The Fed is planning to buy at a rate of about 75 billion a month, and of course they are still reinvesting the payouts from their vast hoard of MBS. That's been over 30 billion a month.

For scaling purposes, working from the October Monthly Treasury Statement and the September retail sales report.
I don't see any way in which such a large injection of money would not cause commodity inflation (temporarily). The Fed seems to have decided that if they were going to do it, they'd better really do it.

Another way to scale this is to consider that on a month-by-month basis, the Fed is injecting far more money into the economy with these purchases than the 2009 stimulus bill ever did.

From the consumer's point of view, personal incomes are not increasing very rapidly at all. (I covered personal income trends with the Q3 advance GDP post and in this post.) Over time, the increase in consumer spending is going to be mostly limited to the increase in personal disposable income. Last quarter's annualized real increase was 13.5 billion. That's why prices have been coming down.

Thus the consumer will spend more on basics and less on discretionary.

This amounts to a significant dollar devaluation, and retailers are at their high-flow season. They have been pretty aggressive with the prices so far in order to get market share. However they now have to wonder about restocking prices.

Basically the Fed is forcing a lot of sellers to raise their prices, but it does not control the ability of the average person to pay those prices. Over the short term, people will probably spend more to get buy without constricting total spending, unless they are going week-by-week. Over the longer term, people will just buy way less discretionary goods. To put it starkly, if the average consumer is covering inflation in living costs by borrowing these days, that consumer is headed to BK court.


The expected effect on prices depends on whether the goods are substantially imported or internally generated, any replacement effects possible, and degree of flexibility. Consumers do not have to buy gold and silver jewelry - they do have to buy food, utilities and transportation.

One of the most vicious expected effects of this move will be in services. Services are where we have been seeing most of our employment gains. Services such as insurance and phone/internet/cable should see increased competition and lower market penetration. That will have a detectable effect on employment, wages and consumption.

In the US, jobs and thus wages are dependent on volume of transactions rather than pricing. Failure to understand this basic fact is what led the Fed not to predict this recession and apparently to plan this Triple Lindy. Unfortunately, it's the working and middle class that get to take the leap.

Also China and India are getting pushed out onto the diving board. They have got to be extremely unhappy about this.


Comments:
I live in Canada, which is not in the same dire condition the U.S. is, but given that you're our largest trading partner, things are not rosy.

I grew a large garden this summer and it seems like much of the fall was spent canning and laying away food. When we shop, we tend to eschew regular items and just cherry pick sales. I notice the retailers are catching onto this and introducing limits where they didn't exist before.

Prices in the grocery store are definitely up. $4 for a loaf of rye bread that was $2 two years ago?!? Gasoline is up $0.10 per litre, and we're expecting our heating prices to climb this winter.

So the bottom line is that we're not spending anything we don't have to.

Today is my birthday and I asked my wife not to go crazy buying me presents. Our big extravagance was a trip to a local culinary arts outfit so I could buy a better spatula ($9) for making crepes. No DVDs, no electronics, iPods, etc.

For X-mas everyone is getting coupons for baking (I make excellent gourmet ice cream) and studio portraits (I own a studio). The flood of advertising flyers will be for naught as we're just not opening our wallets this year. I say that as a member of a household with over $70,000 CDN in take home pay, no mortage, and some credit card debt we're intent on eliminating.

Whatever the heck your government is pumping all this money into, it's not going to stimulate consumer spending, that's for damn sure.
 
government is pumping all this money into, it's not going to stimulate consumer spending, that's for damn sure

It's the old adage inflation benefits those with first access to money. I am disgusted with it on so many levels I can hardly think straight.
 
In the US, jobs and thus wages are dependent on volume of transactions rather than pricing. Failure to understand this basic fact is what led the Fed not to predict this recession and apparently to plan this Triple Lindy.

That makes sense. In my other ear, I'm hearing the establishment line that $600B is a small percentage of total money supply, or total value of the commodities market. Basing the analysis on transaction volumes makes more sense to me.

Another aspect to this is that one of the audiences (maybe the primary audience) that the Fed is aiming at is other CB's. They're basically making it clear that if anybody out there was thinking about starting competitive devaluations, they may as well not try.

I'm quite ready to believe that the Fed underestimated the effects of their warning shot.
 
Neil - there is yet a worse scenario, although if you look at the markets at least there has been some response. So far. The very worst possibility is no response at all.

This inflation will emerge other places, as Sean helpfully reminds us. In many ways, the Canadian economy is seeing the inflation internally because their economy IS healthier - retailers and producers are maintaining margins to a far greater extent than in the US.

Also, their tax structure is quite different than ours, and it slightly accentuates the effect of inflation.

In any case, inflation is "out there", and the worst case scenario is that the Fed move could restrain international trade. India, in particular, has been seeing hard inflation.

Prices are set on the margin. Small supply/demand changes on the order of 1 or 2% can sometimes shift pricing substantially over time.
 
Sean - thanks for the perspective.

That is a good income, but as we have discussed on this blog for a while, a lot of spending depends on expectation.

People who are conservative financially (older and wiser too), such as you and your wife, do not respond to higher prices by hollering "hey, let's spend it while we've got it!" Instead, they tend to build up their piggy bank in the expectation of yet higher prices. And unfortunately, especially in the US, it is mostly the financially conservative who now have the money to spend.

I was just congratulating myself this morning on my last purchase of forever stamps, but I do not feel like running out to the post office to buy more.
 
> a lot of spending depends on expectation

My expectation is that the U.S. economy is going to belly flop once foreclosuregate really gets rolling. Nothing like taking fraudulent loans and following them up with illegal foreclosures using forged documentation on a massive scale. That still has to come home to roost.

This is not to say that it will be the cause of the belly flop, but it will rip the scab off and let the American public see the mess of underfunded pensions, bankrupt state goverments, insolvent banks propped up with public funds, etc.

We're putting some of our $$$ into the bank and some of our $$$ into gold lest we wake up one morning to discover the dollar has devalued down to nothing.

The Canuck economy is tightly enough integrated with yours that whenever you folks are injured, we bleed too.
 
Call me sometime when you have no [middle] class.
 
I notice the retailers are catching onto this and introducing limits where they didn't exist before.

I've seen the opposite here. Here you don't get the sale price unless you buy in large amounts. For example, Mac-n-cheese which was $1.09 on sale for 99 cents but 49 cents if you buy at least 8. Just pushing demand forward. Maybe it'll change here in the coming months.
 
I was just congratulating myself this morning on my last purchase of forever stamps, but I do not feel like running out to the post office to buy more.

Isn't that how Charles Ponzi got his start?
 
If you were a immigrant would you choose the USA now ? If you could leave now and avoid the most
painful consequences of the Fed's action would you do so ? Capital restrictions coming soon.
Sporkfed
 
We don't need no stinkin' capital restrictions!

The U.S. is the only country which taxes its citizens' income no matter where they made it, no matter where they live. Not only that, the IRS restrictions are so onerous and the punishments so severe that many foreign financial institutions refuse to deal with Americans, period. The only way to escape the IRS is to renounce one's citizenship, which involves paying a prohibitive one-time wealth tax. So they get you there, too.
 
MOM,

In the US, jobs and thus wages are dependent on volume of transactions rather than pricing. Failure to understand this basic fact is what led the Fed not to predict this recession and apparently to plan this Triple Lindy.

There are so many failures to understand. My personal favorite, as you can probably guess by now, is looking at "averaged" data within the Flow of Funds reports. The distribution of that income, debt, and savings is far more important than the summarized results.

As more and more income shifts from the lowest paid workers to upper management (based on the "success" of job cutting and job outsourcing) there is less and less ability for typical mortgage payments to be made.

That's my theory on it anyway and I'm sticking to it.
 
One more thought.

I was just congratulating myself this morning on my last purchase of forever stamps, but I do not feel like running out to the post office to buy more.

I backed up the truck when they first came out. However, the self congratulation process slowed when I started paying more of my bills online. I now need to live longer than I originally intended to make hindsight show that it was a good deal.

But hey, at least it gives me a reason to hang in there long-term. I'm just stubborn enough to never die based solely on forever stamp purchases, lol.
 
Mark:

e-Bay

That is all.
 
Neil,

Don't remove my reason to live, lol. ;)
 
I'm not exactly any calmer now, but it does occur to me Bernanke just went all in. If employment doesn't improve, and after the last two QE's had no effect on employment, I don't see how the third will, and if oil runs to $100 a barrel, which doesn't seem too far-fetched to me, Bernanke is going to have a grandstanding Congress to deal with.

Couldn't happen to a nicer guy.

Unfortunately, it might be too little, too late for what's left of the middle class.
 
"Whom the gods would destroy, they first make mad." Just as true today as it was 2500 years ago.
 
As always, I'm two days behind in comprehension. Could you elaborate on this when you get a chance?

'In the US, jobs and thus wages are dependent on volume of transactions rather than pricing. Failure to understand this basic fact is what led the Fed not to predict this recession and apparently to plan this Triple Lindy. '
 
Gordon,

Some argue that inflation will create jobs. I do not.

If customers don't get raises to pay for the higher priced goods, then they will buy fewer products.

Picture a department store that raises prices by 10% but then sells 10% fewer products.

It certainly won't be hiring new workers and may even lay some off. Fewer workers would be needed to restock shelves and sell items to the customers.

Therefore, if Bernanke pushes up the cost of products by stoking further commodity inflation but fails to push up wages by a similar amount (as seen in the 1970s), then his attempt to rescue our economy will do more harm than good (as also seen in the 1970s).
 
Gordon - think of your own situation.

Lower margins = lower merchandising expenditures (price means far more about sales). You just don't get the same return on merchandising in this environment.

In general this leads to less product introductions and fewer products stocked with more attention on value, or a shift to cheaper product lines.

Less discretionary spending means less shipments and fewer truckers, warehouse workers, etc.

Services will probably turn in a 500K shift from actual to expected employment over three quarters (not all cuts, but less hiring than planned in many cases).

Because needs spending is pretty fixed, the money comes out of discretionary income, and that concentrates expenditure cuts for population segments in certain areas and on certain products, which leads to employment and income cuts.

In an environment like this, consumers may spend more on pasta, but the spending on pasta won't be enough to boost hiring there much or at all, and the relative cuts in say TVs or clothing will produce far more negative shifts in employment because they are concentrated.

Lottery ticket purchasing should be pretty strong, that is true.
 
Lottery ticket purchasing should be pretty strong...

Shhhh! Don't point that out to them! The states already count on the lotteries to fund big chunks of state services. If they get the idea that bad economic policy increases lotter sales....
 
As my boyfriend pointed out to me today, Monet got his start by winning the lottery. Guess there's reason to buy after all!
 
Thanks, guys.
 
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