Posts filed under “Think Tank”
The good thing about earnings season is that it allows us to focus our attention again to company fundamentals and less so on what the government will do to ‘fix things.’ Regardless of whether it was just inventory restocking or signs of a real recovery, Intel’s results being well received has a better feeling to it than a short term bump that the market has gotten from some government initiative since the crisis started. Stocks have shrugged off the distress at CIT and hopefully it has more to do with confidence that its competitors can fill in the hole rather than a resignation that it will join the growing list of bailed out companies who only exist to pay off its debts and government obligations instead of growing (Zombie). With the drop in mortgage rates, the MBA said refi’s rose 17.7% but purchases fell by 9.4% to a 7 week low. ABC confidence rose 1 pt to -51. CPI, NY Fed survey and IP are also key today. China’s FX reserves topped $2 trillion for the first time in Q2. UK jobless claims rose much less than expected and at its slowest pace since May ’08.
Good Evening: Yesterday’s stock market rally continued today when neither the earnings reports nor the economic releases contained any bombshells. CSX, JNJ, and GS all reported positive earnings, though only Goldman really surprised to the upside. Of course, since GS had its rally yesterday after the Whitney upgrade, the company’s shares barely managed to hold…Read More
> Jim has run Bianco Research out of Chicago since November 1990. He has been producing fixed income commentaries with a circulation of hundreds of portfolio managers and traders. Jim’s commentaries have a special emphasis on: money flow characteristics of primary dealers, mutual funds, hedge funds, futures traders, banks, and institutional investors. Prior to founding…Read More
May Business Inventories fell 1%, .2% more than expected and April was revised down by .2%. It’s the 9th straight month of declines. With sales down .1%, the inventory to sales ratio fell to 1.42 from 1.43 and its at the lowest level since Oct ’08 when it was at 1.36. The record low was…Read More
There is a reason I call this column Outside the Box. I try to get material that forces us to think outside our normal comfort zones and challenges our common assumptions. I have made the comment more than once that is it unusual for two major bubbles to burst and for the conversation to be all about rising inflation and not a serious problem with deflation.
As Niels Jensen pointed out last week, the most important question that an investor can ask is whether we are in for deflation or inflation. And this week we read a well reasoned piece on deflation. This is one of the more important essays I have sent out. You need to set aside some time to absorb this one.
Van Hoisington and Dr. Lacy Hunt give us a few thoughts on why they think it is deflation that will ultimately be the problem and not inflation we are dealing with today. This week’s letter requires you to think, but it will be worth the effort.
And let me quote a few sentences in the middle of this letter about taxes which you need to think about.
“Thus Barro and Perotti are saying that each $1 increase in government spending reduces private spending by about $1, with no net benefit to GDP. All that is left is a higher level of government debt creating slower economic growth.”
“The most extensive research on tax multipliers is found in a paper written at the University of California Berkeley entitled The Macroeconomic Effects of Tax Changes: Estimates Based on a new Measure of Fiscal Shocks, by Christina D. and David H. Romer (March 2007). (Christina Romer now chairs the president’s Council of Economic Advisors). This study found that the tax multiplier is 3, meaning that each dollar rise in taxes will reduce private spending by $3.”
Now, if you put all of the various inputs together, Hoisington and Hunt show that theory suggests we will soon be dealing with deflation. It’s counter-intuitive to what we hear today, which is why the Bank for International Settlements used the stagflation word in a recent report. The transition that is coming will not be comfortable….
John Mauldin, Editor
Outside the Box
Quarterly Review and Outlook
Second Quarter 2009
DEBT ACTS AS A BRAKE ON THE MONETARY ENGINE
One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.
For example, total commercial bank loans have declined over the past 1, 3, 6, and 9 month intervals. Also, recent readings on bank credit plus commercial paper have registered record rates of decline (Chart 1). The FDIC has closed a record 52 banks thus far this year, and numerous other banks are on life support. The “shadow banks” are in even worse shape. Over 300 mortgage entities have failed, and Fannie Mae and Freddie Mac are in federal receivership. Foreclosures and delinquencies on mortgages are continuing to rise, indicating that the banks and their non-bank competitors face additional pressures to re- trench, not expand. Thus far in this unusual business cycle, excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent. The 100% plus expansion in the Fed’s balance sheet (monetary base) has done nothing to rekindle borrowing and lending or revive even the smallest spark of inflation. What is clear is that as long as private market factors in the monetary/credit 1creation process are shrinking, as they are now, the risk for the economy is deflation, not inflation.
THE COMPLEX MONETARY CHAIN
The link between Fed actions and the economy is far more indirect and complex than the simple conclusion that Federal asset growth equals inflation. The price level and, in fact, real GDP are determined by the intersection of the aggregate demand (AD) and aggregate supply (AS) curves. Or, in economic parlance, for an increase in the Fed’s balance sheet to boost the price level, the following conditions must be met:
- The money multiplier must be flat or rising;
- The velocity of money must be flat or rising; and
- The AS or supply curve must be upward sloping.
The economy and price changes are moving downward because none of these conditions are currently being met; nor, in our judgment, are they likely to be met in the foreseeable future.
Aggregate demand (AD) is planned expenditures for GDP. As defined by the equation of exchange, GDP equals M2 multiplied by the velocity of money (V). M2 equals the monetary base (MB) multiplied by the money multiplier (m). Professors Brunner and Meltzer proved that m is determined by the currency, time, and Treasury deposit ratios, as well as the excess reserve ratio. The money multiplier moves inversely with the currency, Treasury deposit ratios, and excess reserve ratios and positively with the time deposit ratio. For example, if those ratios rise on balance, then m will decline. By algebraic substitution AD(GDP) = MB*V*m. In our present case, the massive increase in the Fed’s balance sheet has created a sharp surge in excess reserves, and thus m has fallen.
Obviously the preceding paragraph is as clear as mud. It is included to provide mathematical proof of the complex connection between monetary actions and real world results. The practical and straightforward fact is that GDP has declined in the face of a surge in M2 growth. The labor market equivalent of GDP (aggregate hours worked) has declined at a record rate over the last 18 months, the entire span of the recession (Chart 2). That is, the monetary surge was totally offset by other factors; thus, the recession deepened and inflation was nonexistent.
The conventional wisdom is that the massive increase in excess reserves might eventually be used to make loans and reverse the economic contraction now underway, or that the velocity of money might increase. First, there is a very good explanation for the surge in excess reserves. The Fed now pays interest on its deposits, so banks have been incentivized to shift transaction deposits from riskier alternatives to the safety and liquidity offered by the Fed. Historically transaction deposits at the banks have fluctuated around 3% to 7% of a bank’s balance sheet. In the second quarter, excess reserves averaged $800 billion which is 4.4% of the $18 trillion of bank debt (including off balance sheet). If this is the amount needed for transaction purposes, then this “high powered” money is not available for making loans and investments.
Category: Think Tank
There will be no bath tub shaped recovery in Singapore and indeed it could be a V as they revealed that Q2 GDP rose 20.4% q/o/q and that is well above the consensus gain of 13.4%. They raised their ’09 GDP forecast range to -4% to -6% from -6% to -9%. Australia June business confidence…Read More
Good Evening: U.S. stocks enjoyed a broadly based rally today, as investors took a Meredith Whitney upgrade of Goldman Sachs prior to its earnings release tomorrow as a cue to buy not only financial names, but the rest of the tape as well. Volume was light, and measures of volatility melted like a San Antonio…Read More
With the sharp drop in the 10 yr bond yield over the past month after touching 4%, the move has retraced almost 50% of the rise from the 2.5% level that occurred right after the FOMC announced a step up of their QE policy on March 18th and said they were going to start buying…Read More
~~~ STOCKS As expected, the S&P has declined and found initial support between 875 and 885. A number of short term indicators are a bit oversold, and yesterday there were more puts than calls traded. This suggests that a bounce is likely that could extend to 900-910. However, it is unlikely that the correction from…Read More
Category: Think Tank
It’s not even the opening yet and the S&P futures have already had a 15 point range from its open last night. Asian stocks got hit hard due to political uncertainty in Japan, word of North Korea’s leader turning ill (no pun intended) and possibly a push out to 2010 an economic agreement between Taiwan…Read More