Yesterday’ 1/4 point rate hike was no surprise . . . but the thought processes behind it may be. Consider the conundrum left to Ben Bernanke by his predecessor, Alan Greenspan.
Post market crash, recession, 9/11, and Iraq War, this was a flatlined economy. Anytime a major market takes a 78% whackage, huge swaths of capital gets destroyed. The Fed’s response to this was to slash interest rates to half century lows.
The initial results of this were somewhat predictable: the Housing sector accelerated and the global economy reflated. Back in December 2002 I mentioned that investors might want to watch gold due to the inflationary potential of these ultra-low rates. (Not quite the table pounding of last year, but quite timely).
At the same time, China began building out its infrastructure in anticipation of its Olympic hosting duties. Concurrent to this was the enromosu boom in direct China investment by Western companies, all seeking to dramatically lower their costs.
Technology companies may not be the benficiaries of this — at least not their stock prices. The subsequent economic expansion was atypical and lumpy, unevenly distributed. Leadership came from Housing, Materials, Energy, Industrials and Transports — not your typical bull market leaders. Noticably missing were Technology and Financials. How’s this duality: Job creation was amongst the worst on record, yet profits are at the top of historical ranges. Housing drove employment, consumer spending, and sentiment.
Then there was inflation. Despite the tortured gyrations that the BLS and Fed goes through, only the most myopic or clueless economists continue to deny the robust price increases across industrial metals, health care, housing, energy, precious metals, insurance, food, education, transportation. Indeed, the only place inflation has been well contained has been wages.
Since August 2005, we described what we saw as the cooling beginning in Real Estate. Yet despite this slowing, and its eventual impact on consumer spending, the same inflation pressures remain, mostly due to Globalisation and demand from Asia.
Hence, the conundrum. The Fed cannot risk allowing very apparent commodity inflation pressures to continue to rise unabated; at the same time, the end of the housing rally is clearly in site.
This is the conundrum that led IMO, to the "Pause" line of thinking.
So where does that leave us? Pimco’s Paul McCulley notes that housing related demand for credit is one of the key elements in money growth. Getting the balance right of credit and money supply versus demand, the Monetarists warn us, is a key element in keeping inflation under control.
Meanwhile, there is little evidence that the nation’s "obsession with real estate is abating," notes the WSJ.
The takeaway of all this comes from Harpers magazine, who may have accidentally come up with the most astute visual. Their most recent issue has an article on "The New Road to Serfdom: An illustrated guide to the coming real estate collapse."
That’s supposed to be John Q. Public shouldering the exotic interest-only no-money-down mortgage load in the graphic.
Instead, I think that’s a drawing of how Ben Bernanke must feel: He’s facing monetary pressures at home, a slowing U.S. economy as Real Estate cools, and hot global inflationary forces beyond his control short of forcing a global recession.
A soft landing for a man shouldering that load looks increasingly unlikely.
Early this morning, I caught a few minutes of Stephen Moore’s Supply Side arguments on CNBC re Tax Cuts.
Rather than discuss what some have called Economic’s biggest mistake, and what the Chairman of President Bush Council of Economic Advisors Greg Mankiw described in the third edition of his book Principles of Economics textbook as the work of
"charlatans and cranks," I thought I would simply debunk his Capital Gains Tax Cut argument as increasing treasury receipts:
Moore is arguing that since tax reciepts went up after the Capital Gains Taxes were cut in 2003, it should therefore get all the credit. I would respond simply by going to the charts, and pointing out that THE ABSENCE OF CAPITAL GAINS FROM 2000-20003 is the primary reason.
This first chart shows the pre-tax cut period of October 2000 to March 2003; Gee, anyone want to hazard a guess for why Capital Gains Taxes paid were so low after the Nasdaq dropped 78%?
How about NO CAPITAL GAINS = NO CAPITAL GAINS TAXES!
The second chart shows what happened after the War began in March ’03. Note that the Nasdaq selloff was very similar in depth to the initial 1929 crash.
(And this is before we even mention increased Housing sales due to half century low interest rates and the potential capital gains taxes there)