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Thursday, September 26, 2013

Taper, No, No, No

Okay, here's the deal. I took His Royal Highness Chief No-Nag Metalheart to the heart hospital last week, and we both got the flu there. We are recovering, but you know how that goes - we have all the energy of some prehistoric sloth species at the moment. I'm bitter, because we were looking for the flu shots but they hadn't come in yet. And he has to go back next week. Ulp!

So I have not had the energy to blog the very interesting back-and-forth between the Fed Heads, but the summary I've come up with is that those who truly want to taper this year are now arguing for a formalistic move at the next meeting (in other words, conceding that they've lost the argument), and many are completely opposed.  Therefore there will be no real taper this year. 

The reason why is pretty clear. By any real standard, the conditions that the Fed was trying to address with QE3 have only gotten worse, and although they are still predicting some sort of pickup in the second half, those arguing for a taper will have to wait until that appears before their arguments gain any traction.
It's hard indeed to look at this graph and argue that the economy is picking up speed. The green line, indexed to the right, is the best of the indicators - the YoY change in four-week moving average for initial claims. That is truly benign. However those aren't necessarily a good indicator until after a recession has begun, and that's what the Fed is trying to avert. 

The quite-correlated blue and red series are YoY change in real final sales of domestic product and YoY change in full-time employment. Neither look optimistic at the moment, and since the change in full-time employment follows that blue line, the Fed wants to see the blue line at least stabilize for a few quarters before it tightens anything. The blue line is currently below the post-WWII recession line and it has been. Even if you argue for a new normal, they want to see that thing straighten out and stick for a bit before doing anything. 

And then, it's obvious that housing is interest-rate sensitive, and there is little hope of that blue line straightening out if the housing recovery doesn't at least stay up to about current levels. Nothing about employment suggests that it is feeding a significant spending expansion into the economy at the moment that could overcome a rebound in mortgage rates.

Regarding the blue line, there's reason to worry. Here's another graph:
(Also see Table 11 in the current GDP release - note that -6.6% over the previous four quarters.)
I do watch these two indicators quite carefully for an upper-bound assessment of corporate spending inputs for the next year of economic projections. The top line (net cash flow with inventory valuation adjustment) measures the real flow of money rolling through corporate hands that could be reinvested. The bottom blue line is undistributed profits with both IVA and capital consumption adjustment. 

Historically, sustained weakness in these measures tends to be highly predictive of domestic downturns, and even if everything else looks bad, if these two measures are still growing or cash flow is growing while undistributed profits are not, it generally flags a growth recession not a recession. If you look at the mid 90s growth recession period, you see these two growing and no recession emerged. But right now these two really don't look good. 

You can often see recessions being born more than a year in advance using these two measures. Companies that are not making more money tend to start watching their bottom lines very carefully, and slow cuts in expenses have a ripple effect across the economy. The last two quarters have turned in some rough numbers, with the blue line now being about where it was in Q3 2009. You are not going to see a Fed tightening under these circs.

Tax policy has not helped. Raising capital gains rates is kind of suicidal in these conditions - you need to pump corporate investment, not restrain it.

Now, I do differ from most in believing that the natural trajectory this year was for consumer-side weakness to slowly increase through the year rather than decrease. I may be wrong of course, but nothing I know about how these things work tells me that we could hit the tax increase/sequester peak before late in the third quarter. Which is where we now are, and frankly when I browse around things look pretty slim. Not disastrous, but kind of grinding on the pavement.

The real question, therefore, is why we are not yet in a recession? I think it is not because of the Fed action, but because of the M_O_M fudge factor gained by much higher levels of personal current transfers (i.e. SS, Medicare, SSI, DI, SNAP, etc) feeding into a stability in consumer spending. One could also call this the Europeanization factor, because this is what the European economies have done. They can stay up at very low levels of growth for quite a while because there is much less sensitivity in consumer spending relating to employment. Small weaknesses in employment are smoothed out by the high proportion of consumer spending funded by the government. 
There's a lot of stability to these payments, and so they fund a pretty steady stream of consumer spending:
As you can see, real personal incomes excluding personal current transfers have barely exceeded their pre-recession peak. If you adjusted for increased taxation, they would be about at their pre-recession peak. The very low interest rates currently are a detraction from personal incomes:

The downside of depending on the government welfare income stream to sustain PCE is that consumer spending becomes acutely sensitive to inflation.

There are significant arguments on the taper side, but the reality is that if the Fed ever agreed to QE3, which it did, it is clear that the QE arguments loom larger in their minds than the negative arguments, and it is not realistic to expect them to suddenly abandon this course.   

In short, the Fed theme song for the next meeting is going to be this:


So to make a long story short, the Fed agreed to economic suicide and by God they aren't about to chicken out now!

Funny how people think QE is the opposite of austerity when it in fact is exactly the same thing for the lower 99%. QE being a stealth tax is producing its logical results. But screw logic, we have ideological models!
My cynical side thinks that interest on the Treasury debt is a not-small factor as well. I'd be very curious to know whether this has become an explicit consideration, though.
Multiple "governors" in place to keep the economy just above stall speed.

First, as Richard Koo has noted, any hint of economic growth leads to taper expectations, which (via front-running) cause rates to rise and thereby choke off that same growth.

Second, as many others have noted, growth also leads to increased energy demand (vs. inflexible supply) which leads to higher energy prices, again choking off that same growth.

What the ivory-tower types still don't comprehend is that what growth they have is ENTIRELY due to QE (and losing effectiveness by the day).

I've said it before and I'll say it again and again and again... QE is a one-way street.
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I've said it before and I'll say it again and again and again... QE is a one-way street.

You are implying that T'Paper is a one hit wonder! ;)
Initial claims are so low as to be weird.
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