Europe has been relatively quiet recently, except for occasional bursts of news coming from or about German Chancellor Angela Merkel. The euro has been relatively strong: it has risen a little over 7% against the U. S. Dollar since the beginning of the year. Relative interest rate spreads on sovereign debt in the eurozone have remained relatively steady.
However, there still remains a lot of work to do in Europe and with all the disagreements among the leaders as well as everything else happening in the world the bailouts and other financial relationships are just not getting done. Let’s just say one shouldn’t get too comfortable in this quiet.
Something concrete for the near term: the European banks are starting their second round of stress tests this weekend. This second round is supposed to be “sufficiently stringent” this time.
We’ll see! They sure weren’t very “stringent” the first time around.
The question is whether or not confidence in the European banking and financial system can be returned so that other matters can be dealt with.
Beyond that, meetings will continue among the leaders of the European nations. Whether or not they can craft a bailout plan is still up in the air. In addition, the process for how the nations are to conduct their fiscal affairs also needs to be decided upon. Problems will still linger until they achieve some more coordination in budget-setting…hard for sovereign nations to give up.
But, speaking of sovereign nations, the problem of sovereign debt still overhangs the financial
markets.
Kenneth Rogoff, who co-authored the book “This Time is Different”, stated in Berlin yesterday that Greece and Ireland will need to restructure their debts. (See http://www.bloomberg.com/news/2011-03-02/rogoff-says-debt-restructuring-inevitable-in-greece-ireland.html.)
Rogoff also added that Spain and Portugal may be forced to do the same thing.
Bondholders, he argued, may have to take losses as large as 40 percent of their holdings of this sovereign debt.
“If Spain were to have a restructuring of central government debt, I don’t think it would end there” said Rogoff, “Spain is just too big.” Other countries facing a restructuring might then include Belgium and more.
But, this is not all!
Europe is facing more inflation. For one, the United Nations announced that world food prices rose to a record level in February and may exceed this level over the next few months. Furthermore, the turmoil in the Middle East is not easing price pressures as the pressure on oil prices increases.
The new element in this latter situation is that Asian countries like China and India now have the wherewithal to hedge against the unrest in the Middle East by shoring up their oil reserves. Even as these oil importing countries add to world demand as their economies grow they also have the financial resources to stockpile reserves in a way that presents a new dynamic to global markets.
And, the money is there for this process to continue worldwide: “What can best be described as ‘the unintended consequences of quantitative easing’ (on the part of the Federal Reserve in the United States) have played a major role. With many emerging nations addicted to their dollar currency pegs, easy US monetary policy finds its way into every nook and cranny of the global economy.” This written by Stephen King, group chief economist at HSBC in “Central Banks Risk Wrecking Recovery” (http://www.ft.com/cms/s/0/cab418ce-44c3-11e0-a8c6-00144feab49a.html#axzz1FMM69iWr).
These “unintended consequences” will continue to plague commodity markets worldwide. Nations and investors have the dollars or the access to dollars to keep these prices rising and this access will not go away soon.
So what about an increase in interest rates?
Well, for the twenty-second month the European Central Bank (ECB) held its main interest rate steady at 1%. Jean-Claude Trichet, ECB president, stated that inflation was a worry and although the rate was held at the current level for the time being, it certainly could rise in April.
Inflation in the eurozone was 2.4% in February, above the target limit of the ECB which is 2.0%.
Rising interest rates can only put more pressure on the governments in Europe, just as rising inflation rates can increase calls from Germany for greater government discipline in fiscal affairs.
“Back in Europe” things are still unsettled. As to the undercurrents going on above look out for the following:
First, the bank stress tests will show little or nothing and will give financial markets very little additional confidence in the European banking system;
Second, no agreements will be reached within the European Union until some of the nations within the EU restructure their debt and the pain of the fiscal situation will then become very obvious;
Third, this restructuring of debt and the continued increase in inflation will put Merkel and Germany in an even stronger position to get a more conservative process of fiscal oversight included in any package that the EU agrees upon;
Fourth, the ECB will hold off an increase in its main interest rate for as long as it can so that a rise in the rate will not serve as a cause of the debt restructuring and will allow the leaders in the EU to craft a new relationship in as orderly fashion as possible.
Inflation will continue to rise in Europe and in the rest of the world and this will put central banks under greater and greater pressure to begin to combat the inflation. Politically, this is still going to be very hard because of the mediocre economic recovery now taking place and the political unrest being caused by governmental restructurings. But, that is another story.
Showing posts with label commodity inflation. Show all posts
Showing posts with label commodity inflation. Show all posts
Thursday, March 3, 2011
Wednesday, February 23, 2011
The Music Has Begun Again, Start Dancing?
John Maynard Keynes is remembered for many quotes and one of the most memorable ones is his claim that “In the long run we are all dead.” Keynes wrote this remark to criticize the belief that inflation would acceptably control itself without government intervention. That is, he argued that the theoretically determined equilibrium of an economy was not a good guide to the future in a very volatile economic situation.
The statement has been used, however, as an excuse for choosing the economic policy of a government based short run outcomes. The most prominent short run outcome sought over the past fifty years has been the maintenance of high levels of employment…or, low levels of unemployment.
The problem is that fifty years of government stimulus, basically credit inflation, aimed at achieving low levels of unemployment have created a cumulative build up in debt and a general attitude toward debt that perpetuates a desire for “more-of-the-same.”
And, over this past fifty years, the purchasing power of the dollar has declined by 85%; the under-employed in the country are in excess of 20% of the working force; and the income distribution has become dramatically skewed toward higher income recipients.
Not surprisingly, the economic and financial crisis of the past few years has been met with calls for more fiscal stimulus and wide-open monetary policy. The result: yearly federal government budget deficits of over $1.5 trillion with an estimated cumulative deficit over the next ten years in excess of $15 trillion. In terms of monetary policy, excess reserves in the banking system have reached $1.2 trillion. All this, of course, to get the economy going again.
Here, however, is where moral hazard enters the picture. The behavior patterns of finance people, developed over the last fifty years, “kicks in” once people see that the same old spending habits of the government are still in place.
I call your attention to the opinion piece by John Plender in the Financial Times this morning, “Bad Habits of Credit Bubble Make Worrying Comeback.” (http://www.ft.com/cms/s/0/26d644be-3ea8-11e0-834e-00144feabdc0.html#axzz1EmwjGnnL)
Mr. Plender begins: “Here we go again. The start of the year in debt markets has been marked by record low yields on junk bonds, declining underwriting standards and a return of the more dangerous innovations of yesteryear such as payment-in-kind toggles which allow borrowers to issue more debt to pay the interest bill. Even covenant-life loans, where normal borrowing conditions are shelved, have made a comeback in the leveraged buyout market and elsewhere, at a time when hapless small and medium sized firms are hard pressed to find credit.
A surplus of savings over investment is thus building up in the system and the US is once again accommodating the savings gluttons with an ongoing commitment to loose policy…No surprise, then, that the search for yield is back in evidence. With Federal Reserve chairman Ben Bernanke keeping policy interest rates at rock bottom, investors are being driven into riskier assets such as junk bonds and leveraged loans.”
Has the “music” started up once more so that people must start dancing again? Someone call “Chuck” Prince, former chairman of Citigroup, to get his “take” on the timing.
Fifty year policies are not just present in the economic policies of government. They exist elsewhere as well. Check out the Tom Friedman’s column “If Not Now, When?” in the New York Times this morning. (http://www.nytimes.com/2011/02/23/opinion/23friedman.html?hp)
Here Friedman discusses energy policy: “For the last 50 years, America (and Europe and Asia) have treated the Middle East as if it were just a collection of big gas stations: Saudi station, Iran station, Kuwait station, Bahrain station, Egypt station, Libya station, Iraq station, United Arab Emirates station, etc. Our message to the region has been very consistent: ‘Guys (it was only guys we spoke with), here’s the deal. Keep your pumps open, your oil prices low, don’t bother the Israelis too much and, as far as we’re concerned, you can do whatever you want out back. You can deprive your people of whatever civil rights you like. You can engage in however much corruption you like. You can preach whatever intolerance from your mosques that you like. You can print whatever conspiracy theories about us in your newspapers that you like. You can keep your women as illiterate as you like. You can create whatever vast welfare-state economies, without any innovative capacity, that you like. You can undereducate your youth as much as you like. Just keep your pumps open, your oil prices low, don’t hassle the Jews too much — and you can do whatever you want out back.’”
Fifty years is a long time. The buildup of fifty years of economic policies and energy policies can result in a lot of excess baggage hanging around that must be dealt with. A fifty-year build up not only requires a major re-structuring of nations and economies, it also requires a huge shift in the mindset of many, many people.
You want the deficit to come down in the short run and monetary policy to be reversed because it is potentially inflationary? It just ain’t going to happen in the near term.
You want an energy policy that is going to immediately get us off of oil so that we can stop subsidizing dictators and autocrats in the Middle East? It just ain’t going to happen in the near term.
And, so on and so on…
What seems to be missing is the leadership to change our mindset and develop a new paradigm that will set us on a pathway to re-structure our economy and our lives. I don’t think we want to dance the same old dance we have been doing for the past fifty years. Yet, it seems as if we have no choice but to start dancing again because the bank has begun to play the music once more.
The leadership just does not seem to be here, either in America, or in Europe, or in Asia. And, no one is strong enough to want to inflict on people the consequences of ‘getting the house in order again.’ I guess one can say, in line with the earlier comments of the mayor-elect of Chicago, Rahm Emanuel, that the leadership in the United States (and in Europe and in Asia) has “”let a crisis go to waste!”
The question that is still unanswered is “Has Keynes’ long-run arrived yet or do we still have to wait for it?” If it has not arrived yet, then it is still to come. Payment will be collected sometime. However, if this ‘long-run’ is still to come then my advice to those that work in financial institutions or in the financial markets is…start dancing again if you haven’t already started for the music has begun once again.
The statement has been used, however, as an excuse for choosing the economic policy of a government based short run outcomes. The most prominent short run outcome sought over the past fifty years has been the maintenance of high levels of employment…or, low levels of unemployment.
The problem is that fifty years of government stimulus, basically credit inflation, aimed at achieving low levels of unemployment have created a cumulative build up in debt and a general attitude toward debt that perpetuates a desire for “more-of-the-same.”
And, over this past fifty years, the purchasing power of the dollar has declined by 85%; the under-employed in the country are in excess of 20% of the working force; and the income distribution has become dramatically skewed toward higher income recipients.
Not surprisingly, the economic and financial crisis of the past few years has been met with calls for more fiscal stimulus and wide-open monetary policy. The result: yearly federal government budget deficits of over $1.5 trillion with an estimated cumulative deficit over the next ten years in excess of $15 trillion. In terms of monetary policy, excess reserves in the banking system have reached $1.2 trillion. All this, of course, to get the economy going again.
Here, however, is where moral hazard enters the picture. The behavior patterns of finance people, developed over the last fifty years, “kicks in” once people see that the same old spending habits of the government are still in place.
I call your attention to the opinion piece by John Plender in the Financial Times this morning, “Bad Habits of Credit Bubble Make Worrying Comeback.” (http://www.ft.com/cms/s/0/26d644be-3ea8-11e0-834e-00144feabdc0.html#axzz1EmwjGnnL)
Mr. Plender begins: “Here we go again. The start of the year in debt markets has been marked by record low yields on junk bonds, declining underwriting standards and a return of the more dangerous innovations of yesteryear such as payment-in-kind toggles which allow borrowers to issue more debt to pay the interest bill. Even covenant-life loans, where normal borrowing conditions are shelved, have made a comeback in the leveraged buyout market and elsewhere, at a time when hapless small and medium sized firms are hard pressed to find credit.
A surplus of savings over investment is thus building up in the system and the US is once again accommodating the savings gluttons with an ongoing commitment to loose policy…No surprise, then, that the search for yield is back in evidence. With Federal Reserve chairman Ben Bernanke keeping policy interest rates at rock bottom, investors are being driven into riskier assets such as junk bonds and leveraged loans.”
Has the “music” started up once more so that people must start dancing again? Someone call “Chuck” Prince, former chairman of Citigroup, to get his “take” on the timing.
Fifty year policies are not just present in the economic policies of government. They exist elsewhere as well. Check out the Tom Friedman’s column “If Not Now, When?” in the New York Times this morning. (http://www.nytimes.com/2011/02/23/opinion/23friedman.html?hp)
Here Friedman discusses energy policy: “For the last 50 years, America (and Europe and Asia) have treated the Middle East as if it were just a collection of big gas stations: Saudi station, Iran station, Kuwait station, Bahrain station, Egypt station, Libya station, Iraq station, United Arab Emirates station, etc. Our message to the region has been very consistent: ‘Guys (it was only guys we spoke with), here’s the deal. Keep your pumps open, your oil prices low, don’t bother the Israelis too much and, as far as we’re concerned, you can do whatever you want out back. You can deprive your people of whatever civil rights you like. You can engage in however much corruption you like. You can preach whatever intolerance from your mosques that you like. You can print whatever conspiracy theories about us in your newspapers that you like. You can keep your women as illiterate as you like. You can create whatever vast welfare-state economies, without any innovative capacity, that you like. You can undereducate your youth as much as you like. Just keep your pumps open, your oil prices low, don’t hassle the Jews too much — and you can do whatever you want out back.’”
Fifty years is a long time. The buildup of fifty years of economic policies and energy policies can result in a lot of excess baggage hanging around that must be dealt with. A fifty-year build up not only requires a major re-structuring of nations and economies, it also requires a huge shift in the mindset of many, many people.
You want the deficit to come down in the short run and monetary policy to be reversed because it is potentially inflationary? It just ain’t going to happen in the near term.
You want an energy policy that is going to immediately get us off of oil so that we can stop subsidizing dictators and autocrats in the Middle East? It just ain’t going to happen in the near term.
And, so on and so on…
What seems to be missing is the leadership to change our mindset and develop a new paradigm that will set us on a pathway to re-structure our economy and our lives. I don’t think we want to dance the same old dance we have been doing for the past fifty years. Yet, it seems as if we have no choice but to start dancing again because the bank has begun to play the music once more.
The leadership just does not seem to be here, either in America, or in Europe, or in Asia. And, no one is strong enough to want to inflict on people the consequences of ‘getting the house in order again.’ I guess one can say, in line with the earlier comments of the mayor-elect of Chicago, Rahm Emanuel, that the leadership in the United States (and in Europe and in Asia) has “”let a crisis go to waste!”
The question that is still unanswered is “Has Keynes’ long-run arrived yet or do we still have to wait for it?” If it has not arrived yet, then it is still to come. Payment will be collected sometime. However, if this ‘long-run’ is still to come then my advice to those that work in financial institutions or in the financial markets is…start dancing again if you haven’t already started for the music has begun once again.
Friday, February 4, 2011
It's Your Fault, Not Mine!
The headlines this morning from London: “Fed Denies Policy is Causing Rising Food Prices.” (http://www.ft.com/cms/s/0/5c4aeaea-2fbd-11e0-91f8-00144feabdc0.html#axzz1CzURFR8C)
Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, spoke to the National Press Club yesterday and basically said:
“It’s Your Fault!”
The response: “No, it isn’t!”
Bernanke’s come back: “’Tis too!”
And, so we see the basic defense the leader of our central bank relies upon. “The problem is ‘out there’, it’s not in here!”
Bernanke: “I think it’s entirely unfair to attribute excess demand pressures in emerging markets to U. S. monetary policy, because emerging markets have all the tools they need to address excess demand in those countries. It’s really up to emerging markets to find appropriate tools to balance their own growth.” (http://professional.wsj.com/professional-search/search.html?ar=1&dt=4&mf=0&pg=1&ps=25&sb=0&pid=0_0_ES_1000&cnt=&st=4&nfbg=SUDEEP+REDDY)
Throughout his history at the Fed, Bernanke has always seen our problems as coming upon us from someone else or somewhere else in the world. Our problem in the early 2000s was the fault of the Chinese because they saved too much! Our problem in the housing bubble was that others in the rest of the world purchased the mortgage-backed securities being created to finance residential real estate! Our problem in the summer of 2007 was that inflation still had to be combated because prices were rising too fast in the rest of the world. (See chart in this article on world food prices to confirm this:
http://www.nytimes.com/2011/02/04/world/04food.html?ref=todayspaper.) And, now, other countries are not acting strongly enough to combat rising food prices in the rest of the world.
Here is the problem: Bernanke is so focused on the fact that nothing is our fault that he is constantly behind the curve. Yesterday, I wrote in my post
“But, why should we expect the Federal Reserve to back off from QE2 any time soon? Chairman Bernanke has been late on every shift in monetary policy since he has been a member of the Board of Governors. Why should we expect anything different this time?” (http://seekingalpha.com/article/250838-long-term-treasury-yields-and-inflationary-expectations)
Bernanke’s thought process might be correct in a world in which the international flow of capital was severely constrained. Bernanke is a first class world academic when it comes to studies of the Great Depression of the 1930s. That world was a world of severely restricted flows of capital between countries.
In fact, the limited international capital movements was a part of the policy prescriptions of the world at that time. John Maynard Keynes was a strong advocate for restricted capital flows in the world. (http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell)
Keynes, and other participants in the construction of the Bretton Woods international financial system, built constrained international capital flows into the very rules of the post-World War II monetary framework.
The reason for restricting international flows of capital? In such a regime, countries could conduct their economic policies independently of one another. In such an environment, a country could forget about what was happening “out there” and focus solely on what was happening “in here.”
The world didn’t cooperate with this desire to limit capital flows and as the barriers to international flows of capital broke down in the 1960s, the Bretton Woods system had to go. The final nail in the coffin was applied by President Richard Nixon on August 15, 1971 as he took the United States “off gold” and floated the value of the United States dollar.
Capital flows freely around the world and so the United States cannot just act as if it is the only player in the world. Yet, this seems to be exactly what Bernanke wants.
Answer this: what three countries or organizations in the world hold the most amount of U. S. Government debt?
In order of magnitude: the United States with $1,138,166 million as of the close of business on February 2, 2011 ($1.138 trillion); China, a little less than $0.9 trillion; and Japan, a little less than China.
What can we take-away from this?
Capital is flowing freely throughout the world!
The contribution made by the United States to these flows is enormous!
The flows of this capital must look like a huge wave coming up on their shores, like a tsunami hitting most of the countries in the world!
But, Mr. Bernanke argues that “…emerging markets have all the tools they need to address excess demand in those countries. It’s really up to emerging markets to find appropriate tools to balance their own growth.”
What he really is saying is, "I want to do my thing...and I am big enough to do what I want. You just have to live with what I do. I can have an independent economic policy because of my size. Too bad you are not big enough to be able to conduct your own independent economic policy."
Mr. Bernanke has invested too much of his intellect in the study of the 1930s. Mr. Bernanke needs to become a part of the 2010s.
Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, spoke to the National Press Club yesterday and basically said:
“It’s Your Fault!”
The response: “No, it isn’t!”
Bernanke’s come back: “’Tis too!”
And, so we see the basic defense the leader of our central bank relies upon. “The problem is ‘out there’, it’s not in here!”
Bernanke: “I think it’s entirely unfair to attribute excess demand pressures in emerging markets to U. S. monetary policy, because emerging markets have all the tools they need to address excess demand in those countries. It’s really up to emerging markets to find appropriate tools to balance their own growth.” (http://professional.wsj.com/professional-search/search.html?ar=1&dt=4&mf=0&pg=1&ps=25&sb=0&pid=0_0_ES_1000&cnt=&st=4&nfbg=SUDEEP+REDDY)
Throughout his history at the Fed, Bernanke has always seen our problems as coming upon us from someone else or somewhere else in the world. Our problem in the early 2000s was the fault of the Chinese because they saved too much! Our problem in the housing bubble was that others in the rest of the world purchased the mortgage-backed securities being created to finance residential real estate! Our problem in the summer of 2007 was that inflation still had to be combated because prices were rising too fast in the rest of the world. (See chart in this article on world food prices to confirm this:
http://www.nytimes.com/2011/02/04/world/04food.html?ref=todayspaper.) And, now, other countries are not acting strongly enough to combat rising food prices in the rest of the world.
Here is the problem: Bernanke is so focused on the fact that nothing is our fault that he is constantly behind the curve. Yesterday, I wrote in my post
“But, why should we expect the Federal Reserve to back off from QE2 any time soon? Chairman Bernanke has been late on every shift in monetary policy since he has been a member of the Board of Governors. Why should we expect anything different this time?” (http://seekingalpha.com/article/250838-long-term-treasury-yields-and-inflationary-expectations)
Bernanke’s thought process might be correct in a world in which the international flow of capital was severely constrained. Bernanke is a first class world academic when it comes to studies of the Great Depression of the 1930s. That world was a world of severely restricted flows of capital between countries.
In fact, the limited international capital movements was a part of the policy prescriptions of the world at that time. John Maynard Keynes was a strong advocate for restricted capital flows in the world. (http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell)
Keynes, and other participants in the construction of the Bretton Woods international financial system, built constrained international capital flows into the very rules of the post-World War II monetary framework.
The reason for restricting international flows of capital? In such a regime, countries could conduct their economic policies independently of one another. In such an environment, a country could forget about what was happening “out there” and focus solely on what was happening “in here.”
The world didn’t cooperate with this desire to limit capital flows and as the barriers to international flows of capital broke down in the 1960s, the Bretton Woods system had to go. The final nail in the coffin was applied by President Richard Nixon on August 15, 1971 as he took the United States “off gold” and floated the value of the United States dollar.
Capital flows freely around the world and so the United States cannot just act as if it is the only player in the world. Yet, this seems to be exactly what Bernanke wants.
Answer this: what three countries or organizations in the world hold the most amount of U. S. Government debt?
In order of magnitude: the United States with $1,138,166 million as of the close of business on February 2, 2011 ($1.138 trillion); China, a little less than $0.9 trillion; and Japan, a little less than China.
What can we take-away from this?
Capital is flowing freely throughout the world!
The contribution made by the United States to these flows is enormous!
The flows of this capital must look like a huge wave coming up on their shores, like a tsunami hitting most of the countries in the world!
But, Mr. Bernanke argues that “…emerging markets have all the tools they need to address excess demand in those countries. It’s really up to emerging markets to find appropriate tools to balance their own growth.”
What he really is saying is, "I want to do my thing...and I am big enough to do what I want. You just have to live with what I do. I can have an independent economic policy because of my size. Too bad you are not big enough to be able to conduct your own independent economic policy."
Mr. Bernanke has invested too much of his intellect in the study of the 1930s. Mr. Bernanke needs to become a part of the 2010s.
Monday, November 29, 2010
Is the United States Making the Emerging Nations Stronger?
Why is the rate of inflation so low in the United States when the government has pumped huge amounts of debt into the country and the Federal Reserve has loaded the financial system with large amounts of liquidity?
The same question was asked in the 1990s. Where was the United States inflation?
The answer for the 1990s…and for the present time period…is that the United States has exported inflation to the rest of the world…more specifically…Asia. As the accompanying chart shows, inflation seems to be heading up in Asia…as it is also heading up in many other emerging nations.
As reported in the LEX column of the Financial Times yesterday, global inflation has seemingly bifurcated. In the developed countries the current inflation rate is below 2 percent (Australia and the UK are exceptions). Morgan Stanley expects a 1.5 percent rate of growth for the wealthier countries in 2010. “By contrast, the emerging market inflation rate is about three times higher—expected at 5.4 percent in 2010…” (http://www.ft.com/cms/s/3/0c01f5a4-fb0d-11df-b576-00144feab49a.html#axzz16h9jdCiK)
The post-financial crisis stimulus is now feeding the inflation in the emerging countries. “A significant portion of the river of cheap money flowed into commodity markets. The initial price recovery caused no problems, but the trend now threatens to create a vicious circle.”
There is also the “carry trade” which takes United States dollars throughout the world seeking higher interest rates. This flow is certainly not insignificant.
In these days, it seems like it is very difficult to contain the international flows of capital. Maybe policy makers need to give this a little more weight in their policy discussions.
There is an argument that central banks, in some Asian countries, kept their interest rates “appropriately low” over the past year or so because of “concerns about the strength in their developed-market trading partners” especially the United States. Now, with inflation threatening to get out-of-hand in the emerging nations, these same central banks are faced with the need to raise their domestic interest rates higher and higher. (See “Emerging Wild Card: Inflation”: http://www.ft.com/cms/s/3/0c01f5a4-fb0d-11df-b576-00144feab49a.html#axzz16h9jdCiK.)
The article continues: “One conundrum for investors is how more aggressive tightening would play out in the currency markets. Most investors have been operating on the assumption that with the Fed keeping interest rates at zero for the foreseeable future, any moves by emerging-market countries to raise interest rates would attract even more money from yield-hungry investors.”
This seems to reflect a cumulative problem. By keeping interest rates low in the United States, dollars are flowing out into the rest of the world. This out-flow is threatening to bring about greater amounts of inflation in the emerging nations of the world. In order to combat this rising level of inflation, the central banks in emerging nations are raising interest rates. But, in raising interest rates, more United States dollars flow to these emerging nations.
And the flow of money into dollars from Europe as a “safe haven” has kept the value of the dollar stronger than it otherwise would be in such a situation which just enhances the return to investors from moving into the interest rates in the emerging countries.
And the flow of money into dollars from Europe as a “safe haven” has kept the value of the dollar stronger than it otherwise would be in such a situation which just enhances the return to investors from moving into the interest rates in the emerging countries.
So, the Federal Reserve continues to inject large amounts of reserves into the banking system, hoping to get the United States economy going again. But, individuals, families, and small businesses do not seem to want to be borrowing. Only large, healthy companies seem to be borrowing and piling up cash reserves. The money the Fed is printing seems to be going off-shore.
Therefore, instead of stimulating the United States economy, the Federal Reserve seems to be stimulating the emerging countries of the world. The two results of this seem to be that the United States is not getting stronger, but it is helping the rest of the world to get relatively stronger. The rest of the world needs to keep inflation under control, but the emerging nations feel the relative shift in power within the world and are taking more and more advantage of this increased power. See reports on the recent G-20 meeting. (http://seekingalpha.com/article/236430-release-from-the-g20-what-more-needs-to-be-said)
Only strong, self-disciplined countries come out on top. Right now, the United States is anything but self-disciplined and it is finding that its relative strength is slipping away. The unfortunate thing is that in its lack of self-discipline, the United States is feeding the rising relative strength of the emerging nations in the world. This is our fault, not the fault of other nations within the world.
Only strong, self-disciplined countries come out on top. Right now, the United States is anything but self-disciplined and it is finding that its relative strength is slipping away. The unfortunate thing is that in its lack of self-discipline, the United States is feeding the rising relative strength of the emerging nations in the world. This is our fault, not the fault of other nations within the world.
Thursday, October 21, 2010
Are There Bubbles All Around?
One thing we learned in the 1990s and the 2000s is that there can be asset bubbles in the economy without growth in either money stock variables or increases in consumer (flow expenditure) price inflation. The financial system seems to be flexible enough so that it can leverage up where it wants to even though monetary policy and consumer spending seem to be “in control”. This is the lesson of modern “financial engineering.”
However, the monetary statistics are not benign for most of the time period from January 1961 up to September 2008. During this time period, the monetary base which is supposedly under the control of the Federal Reserve System rose at a compound annual rate of slightly more than 6%. Total credit during this time period rose much more rapidly. Consequently, the United States experienced a period if “credit inflation” that dominated everything going on during this 47 years or so. This secular inflation drove the financial innovation that took place as the whole financial system took on more-and-more leverage and more-and-more risk.
Since September 2008, the Federal Reserve has caused the Monetary Base to increase explosively by more than 130%. However, the banking system is not lending and much of these funds seem to have ended up on the balance sheets of the banking system. Excess reserves in the banking system went from about $2 billion in August 2008 to almost $1.2 trillion in February 2010. Excess reserves for September 2010 averaged slightly below $1 trillion.
Even with all of these excess reserves, the current concern is whether or not the economy will go into a period where prices actually decline. That is, might the United States be headed for a period of deflation?
Everything mentioned above is true. Yet, there is more going on in the economy than just what we see here. In some areas, a lot is going on and in these areas we are seeing lots of upward price movement which leads one to ask whether or not these price movements are bubbles or indications of something else taking place. Certainly, the “bubbles” are not increasing employment, or capacity utilization, or getting the economy going again.
I have written about this before: “Where the Action is: The Bond Market”, http://seekingalpha.com/article/230048-where-the-action-is-the-bond-market. I wrote in this post:
“There is a lot of money in the financial markets…in the shadow banking system…and worldwide.
Where is the action taking place?
Well, for one, in the bond market. We have major companies issuing bonds at ridiculously low interest rates.”
Of course we know that government bond prices are inordinately high causing yields to be excessively low. But, this is also true in the market for high-grade corporate debt and for junk bonds. One could certainly argue that there might be “asset bubble” in the bond markets.
Thank you shadow banking system!
And, the cash continues to build up on the balance sheets of “healthy” large corporations. It also appears as if many hedge funds and private equity funds are attracting “large bunches” of new money.
But, capital is almost perfectly mobile in the modern world: it can escape almost everywhere.
Because of this, writers like Martin Wolf have argued that one of the goals of American leadership is to “inflate the world” in order to get United States economic growth going again.
So, are we seeing the results of this?
Well, we might be seeing this flow of capital going into world commodity markets and also into emerging markets. There is the possibility that bubbles may be occurring here.
The movement in commodities seems to be worldwide but repercussions are being felt domestically in the United States. (See “Dilemma Over Pricing: From Cereal to Helicopters, Commodity Costs Exert Pressure”, http://professional.wsj.com/article/SB10001424052702304741404575564400940917746.html?mod=ITP_marketplace_0&mg=reno-wsj.) This article indicates that, year-over-year, corn prices are up by 34%, wheat prices are up 34%, milk is up 32%, copper is up 30%, and oil is up 14%. It is also the case that sugar is up about 50% year-over-year.
The question many companies are facing is, “How can we raise prices to cover these costs when the economy is so weak?” A real dilemma!
Funds are also flowing into emerging markets. All one has to do is watch the stock exchanges in those countries. And, all indications are that large companies are looking to locate in many of these markets or acquire firms in these markets. We are also seeing the hedge funds and private equity funds looking in this direction. (See for example, “Buy-outs set to divide private equity”, http://www.ft.com/cms/s/0/726ce11e-dc6d-11df-a0b9-00144feabdc0.html.)
In a world where there is a fluid movement of capital, money is not going to stay at home if the home economy is not strong, structurally. The American economy is having major problems in its economy. Why would “big” money want to invest here? (See, for example, “Globalized Finance: Advantage China”, http://seekingalpha.com/article/229600-globalized-finance-advantage-china.)
The Federal Reserve, and the federal government, may need to change their economic models to include the fact that organizations other than domestically chartered commercial banks can create credit and can cause bubbles to occur anywhere in the world where an opportunity exists.
Modern finance with internationally mobile capital does not seem to exist in the models the leaders of the United States are using. This is one reason for my skepticism of all the new financial reform systems that are being constructed. (See my post “Banking at the Speed of Light”, http://seekingalpha.com/article/208513-banking-at-the-speed-of-light.) Money is becoming more and more fluid and hence less and less controllable.
The American banking system may currently be dormant, but there seems to be plenty of money and plenty of action, elsewhere.
Yes, there are bubbles all around.
However, the monetary statistics are not benign for most of the time period from January 1961 up to September 2008. During this time period, the monetary base which is supposedly under the control of the Federal Reserve System rose at a compound annual rate of slightly more than 6%. Total credit during this time period rose much more rapidly. Consequently, the United States experienced a period if “credit inflation” that dominated everything going on during this 47 years or so. This secular inflation drove the financial innovation that took place as the whole financial system took on more-and-more leverage and more-and-more risk.
Since September 2008, the Federal Reserve has caused the Monetary Base to increase explosively by more than 130%. However, the banking system is not lending and much of these funds seem to have ended up on the balance sheets of the banking system. Excess reserves in the banking system went from about $2 billion in August 2008 to almost $1.2 trillion in February 2010. Excess reserves for September 2010 averaged slightly below $1 trillion.
Even with all of these excess reserves, the current concern is whether or not the economy will go into a period where prices actually decline. That is, might the United States be headed for a period of deflation?
Everything mentioned above is true. Yet, there is more going on in the economy than just what we see here. In some areas, a lot is going on and in these areas we are seeing lots of upward price movement which leads one to ask whether or not these price movements are bubbles or indications of something else taking place. Certainly, the “bubbles” are not increasing employment, or capacity utilization, or getting the economy going again.
I have written about this before: “Where the Action is: The Bond Market”, http://seekingalpha.com/article/230048-where-the-action-is-the-bond-market. I wrote in this post:
“There is a lot of money in the financial markets…in the shadow banking system…and worldwide.
Where is the action taking place?
Well, for one, in the bond market. We have major companies issuing bonds at ridiculously low interest rates.”
Of course we know that government bond prices are inordinately high causing yields to be excessively low. But, this is also true in the market for high-grade corporate debt and for junk bonds. One could certainly argue that there might be “asset bubble” in the bond markets.
Thank you shadow banking system!
And, the cash continues to build up on the balance sheets of “healthy” large corporations. It also appears as if many hedge funds and private equity funds are attracting “large bunches” of new money.
But, capital is almost perfectly mobile in the modern world: it can escape almost everywhere.
Because of this, writers like Martin Wolf have argued that one of the goals of American leadership is to “inflate the world” in order to get United States economic growth going again.
So, are we seeing the results of this?
Well, we might be seeing this flow of capital going into world commodity markets and also into emerging markets. There is the possibility that bubbles may be occurring here.
The movement in commodities seems to be worldwide but repercussions are being felt domestically in the United States. (See “Dilemma Over Pricing: From Cereal to Helicopters, Commodity Costs Exert Pressure”, http://professional.wsj.com/article/SB10001424052702304741404575564400940917746.html?mod=ITP_marketplace_0&mg=reno-wsj.) This article indicates that, year-over-year, corn prices are up by 34%, wheat prices are up 34%, milk is up 32%, copper is up 30%, and oil is up 14%. It is also the case that sugar is up about 50% year-over-year.
The question many companies are facing is, “How can we raise prices to cover these costs when the economy is so weak?” A real dilemma!
Funds are also flowing into emerging markets. All one has to do is watch the stock exchanges in those countries. And, all indications are that large companies are looking to locate in many of these markets or acquire firms in these markets. We are also seeing the hedge funds and private equity funds looking in this direction. (See for example, “Buy-outs set to divide private equity”, http://www.ft.com/cms/s/0/726ce11e-dc6d-11df-a0b9-00144feabdc0.html.)
In a world where there is a fluid movement of capital, money is not going to stay at home if the home economy is not strong, structurally. The American economy is having major problems in its economy. Why would “big” money want to invest here? (See, for example, “Globalized Finance: Advantage China”, http://seekingalpha.com/article/229600-globalized-finance-advantage-china.)
The Federal Reserve, and the federal government, may need to change their economic models to include the fact that organizations other than domestically chartered commercial banks can create credit and can cause bubbles to occur anywhere in the world where an opportunity exists.
Modern finance with internationally mobile capital does not seem to exist in the models the leaders of the United States are using. This is one reason for my skepticism of all the new financial reform systems that are being constructed. (See my post “Banking at the Speed of Light”, http://seekingalpha.com/article/208513-banking-at-the-speed-of-light.) Money is becoming more and more fluid and hence less and less controllable.
The American banking system may currently be dormant, but there seems to be plenty of money and plenty of action, elsewhere.
Yes, there are bubbles all around.
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