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|6.12.06 @ 1:44PM|#
I believe the main reason markets have reacted so strongly to Bernanke's comments is that he has hit on 2 of the issues market players are currently most worried about. Will the spike in oil prices leak over into a more generalized price inflation and are we heading towards a recession.
Bernanke's recent comments seem to excarbate both fears and have contributed to the sell-off.
That said, while there is a grain of truth in both effects, the overall economy seems to be in reasonable shape. Growth and productivity remain high, unemployment is low, and inflation (though higher than expected) is not at the level where everyone needs to jump off buildings.
I think a lot of it is Bernanke still needs to figure out how much information to provide the market and a bit of an overreaction by market players.
In my mind it is a pretty good buying opportunity.
|6.12.06 @ 2:42PM|#
"Will the spike in oil prices leak over into a more generalized price inflation"
Absent an increase in the money supply, an increase in the price of oil would lead to a decrease in the price of other goods. In other words, the spike in oil prices is just another symptom of the underlying problem, not the problem itself.
Furthermore, the Bank of Japan has started turning off its spigot, which was what allowed the yen carry trade, which helped hide the cost of our monetary expansion. The wild ride is coming to an end, and it will soon be time to pay the piper.
I'm seeing consumer product explosive inflation combined with a long, slow deflation in capital asset prices at the same time. That's gonna cause alot of pain, and the Fed's not going to know what to do about, as it shouldn't be possible according to Bernanke's economic theories.
"and inflation (though higher than expected) is not at the level where everyone needs to jump off buildings."
Are you talking real inflation, or merely the rigged term CPI?
"are we heading towards a recession."
At some point, yes. The only questions that remain after monetary expansion are when and how bad. And they're related - the sooner, the less painful the correction is. We've delayed it for five years now, so it's going to fairly painful if we just let it ride now. But I doubt we will - we're going to dig a deeper hole to delay the inevitable - the incentive in a representative democracy is not long term, it is "in my term".
|6.12.06 @ 2:58PM|#
As I undertand it the rise in oil prices in a result of growing demand from China and India combined with a limited refining capacity and politicaly instability in the middle east reducing supply.
Are you implying, rather, that it is a result of excess liquidity from monetary policy going into commodities rather than equities?
Also, do you see the primary driver of economic growth over the prior 4-5 years a result of excess liquidity from the Fed, rather than underlying economic productivity?
As for inflation I was talking about chain adjusted CPI specifically, but the other measures I have seen PPI, GDP Deflator, also do not seem to be at ridiculously high levels. What is your preferred measure?
When I spoke of recession, of course at some point in the future we will go through another recession, it is just that people on the street are speaking about a recession in the short term, like the next 6 months to a year.
By capital assets I assume we are discussing housing prices, which by any reasonable standard are certainly overvalued. But I think the main affect of a decrease in housing prices will be a reduction in the amount of refinancings (which would tend to depress consumer spending) and perhaps an increase in non-performing mortgages.
These are certainly real things to worry about, but my understanding is that the fundamental underlying economy is strong.
Warren|6.12.06 @ 3:01PM|#
While the fed can certainly scuttle the economy if it chooses to, it's the total absence of anything resembling fiscal discipline in the Congress that is the bigger threat.
|6.12.06 @ 3:23PM|#
"As I undertand it the rise in oil prices in a result of growing demand from China and India combined with a limited refining capacity and politicaly instability in the middle east reducing supply."
That is [perhaps] a cause in the increase in the relative price of oil. It's hard to say, though, because the monetary expansion tends to cause so much damage to the price structure that it becomes very difficult to trace what is real and what is illusory. For example, if we were still on the gold standard, you'd still be paying no more than a quarter per gallon of gas. In fact, the relative real price of gasoline has trended down for a long time.
"Are you implying, rather, that it is a result of excess liquidity from monetary policy going into commodities rather than equities?"
Yes, that's part of the problem. Actually, the real problem is the imiginary "wealth" that was created by the Fed's printing presses. Where it goes isn't so much the problem as the act of creating it is - those new dollars, over time, siphon the value out of your saved dollars. It's just a better disguised tax.
"Also, do you see the primary driver of economic growth over the prior 4-5 years a result of excess liquidity from the Fed, rather than underlying economic productivity? "
Primary? I guess so, although that's a loaded term. Certainly there has also been productivity gains. But we've masked the pain of liquidating the tech bubble mistakes by creating a housing bubble, which has increased people's perceptions of their wealth, and caused them to over-consume. Alot of people are going to be trapped in houses that are worth significantly less than their mortgage if housing prices start to decline. And at their current levels, it'll only take small percentage declines for people to be in real trouble, especially if they have ARMs.
"are speaking about a recession in the short term, like the next 6 months to a year"
Well, the smart money is that by Jan. 1, 2007, we'll be at the start of a significant recession, unless ole Ben brings out the helicopters or their equivalent. That'll be three years from the bottom of the funds rate, and that historically is a significant time. It is also about a year from the flattening of the yield curve, which is another bellweather for recessions.
"By capital assets I assume we are discussing housing prices"
Those, but not only those. Stocks, in general, are still at relatively high P/E ratios. There are some other distortions that I know of that are related to the housing boom (prices of building material have been skyrocketing).
"These are certainly real things to worry about, but my understanding is that the fundamental underlying economy is strong."
It's not all doom and gloom, but the fundamentals have been severely weakened by the massive expansion in money supply. There's a lot of bad debt out there, not the least of which is the fedgov's debt. The one truth about debt is that it can make you look wealthy and stable for a while, but eventually, you'll either have to work twice as hard to maintain your lifestyle and pay off the previous debt, or you'll have to accept a lesser lifestyle and use the savings to pay off the debt. I see nothing in the current make-up of US politics or society that leads me to believe people are willing to accept either of those scenarios - so we'll be looking at massive gov't interventions in the market. And that's where things will go from bad, but manageable, to awful.
I hope I'm wrong, and the american electorate has more gumption than that. But my read is that it doesn't.
|6.12.06 @ 3:33PM|#
quasibill
Interesting points, although I don't believe that equities are expensive now relative to historical norms. The last time I checked (sometime last week), the P/E of the S + P 500 was something like 14, with a historical average of around 15. Smaller cap stocks were a bit pricey, but not extraordinarily so.
The market has been essentially flat for the last 5 years, while companies have experienced a lot of profit growth, so it is hard to characterize the market as overpriced. 5 years ago certainly, but not now.
As for the money supply, I don't believe that the monetary aggregates have been expanding that rapidly, here is the seasonally adjusted fed data on M2
http://research.stlouisfed.org/fred2/series/M2SL/29/5yrs?cs=Medium&crb=on
which seems to be growting right around the growth rate of the economy. Is there a better measure than M2 that you like to use.
|6.12.06 @ 3:52PM|#
Lanny,
M3 was a better indicator. Unfortunately, the Fed discontinued it in March. Coincidence?
And actually, the rate of expansion right now is slow - you're right, it's probably fairly close to productivity (although we can't get a good read in the absence of M3, and of course, it's extremely difficult to get a realistic measure of productivity growth). The problem is that the past five years is a different story - the damage has already been done. The proof is in the fact that consumer product inflation has reared its head despite the fact that the Fed has been increasing the funds rate for a while now. And despite the fact that further increases are seen as harmful to the economy by most prognosticators.
So Ben's in a bad way - either he lets inflation keep increasing, but protects the capital markets, by not increasing the rate. Or, he can attack inflation by raising the rate, but precipitating a large decline in capital markets.
The S&P 500 (especially the true large caps) aren't the problem in the market. But their P/E ratios are still much higher than the historical lows that are reached during recessions. The important numbers to look at are the averages before the recent (since Greenspan took over the chair) run on monetary expansion began - all historical averages have been skewed by this period.
|6.12.06 @ 3:58PM|#
Who to believe?
http://www.project-syndicate.org/commentary/tetlock1
What this says is doubly true for blog posts.
|6.12.06 @ 7:02PM|#
quasibill,
I don't quite understand why the S + P 500 should be trading at a multiple that implies a recession. After all right now we are not in a recession, if we are trading at 14 times earning when GDP is slowing markedly then I would agree that the market is overpriced. But given that we are not currently in that macro-economic state I don't see why we should price equities that way.
When I calculate the average monthly growth rate of M2 from the fed data, I get a number like .5% per month, against an average of .56% for the entire period.
The same analysis for M3, shows it growing a touch higher .136% per week versus .125% for the whole period.
In either case it does not seem that monetary growth has been hugely profligate in the most recent 5 year period (starting Jan 1 2001).
We may be seeing inflation in certain parts of the economy (i.e. oil, housing related supplies, etc...), but that doesn't necessarily imply a huge growth in general inflation.
|6.12.06 @ 7:04PM|#
sorry...
the 2 different numbers for M2 and M3 growth are for the average per period seasonally adjusted growth rate starting in Jan 1 2001, versus the entire available series.
|6.13.06 @ 8:24AM|#
By my calculations on the M2 (okay, by the St. Louis Fed's chart), we have 2,000 BILLION more dollars in circulation today than we did 6 years ago. You can manipulate that into weekly growth rates all you want (kinda like cops who measure drug busts in grams when its a small amount so they can make it sound bigger), but looked at in that perspective, it's hard to make an honest argument that we aren't inflating the heck out of our money. BTW, that 2,000 billion constitutes nearly a third of all circulating money (according to M2, we're at just under 7,000 billion dollars). That's also a telling statistic. Has our productivity grown 33% in absolute terms over the last six years? If so, we're seeing an absolute revolution of unprecedented scale. I don't buy it.
Regardless, only a supply sider could even make the argument that its okay to even try to inflate to match productivity. Ethically, it's still stealing money from savings - a well disguised tax. And economically, history has proved that the task can't be done. Flipping a coin has been a more accurate predictor of next quarter's numbers than any expert over the last 50 years. And it only gets worse for the experts the further into the future they try to peer. Since Fed actions generally don't play out until 16 months after they're taken, Ben has to be the best expert ever at predicting 5 quarters ahead. I'll flip a coin, thanks.
|6.13.06 @ 8:52AM|#
Maybe he needs to take a correspondence coarse in Greenspanspeak, i.e., how to talk for 2 hours and leave people saying "what the fuck did he say?"
|6.13.06 @ 9:30AM|#
I wasn't suggesting that we grow the money supply at any particular rate, or any other rule for money growth. I was simply stating the fact that monetary growth in the last 5 years, has been about average.
Speaking about growth rates is what economists/scientists do, the raw numbers need to be put into context and the convention that is typically used is to transalate everything into growth rates.
|6.13.06 @ 11:17AM|#
What!
Is this the crystal ball wing of H&R?
Where's Herrick and his crystal balls?
What do they say?
|6.13.06 @ 11:44AM|#
ah, yes "context".
I'm not sure how much "context" is necessary when you state that a little more than 2 of every 7 dollars in circulation today were created out of thin air in the last 6 years. Seems like plenty of "context" is there already.
|6.13.06 @ 1:44PM|#
quasibill,
True, but as I understand it US GDP has grown from around 10 trillion in 2000 to around 13 trillion today.
So 3000 BILLION dollars of income have also been created in the period stated. That is why economic variables are quoted in rates instead of nominal amounts, what matters are the relative growth rates to each other. A 30% increase in the money supply, absent no income growth, is obviously highly inflationary. But a rate of money growth approximately equal to the rate of income growth (with constant monetary velocity) will not lead to inflation.
Again, my comment was that the trend rate of growth is not substantially higher in the prior 5 year period, while GDP growth was also around trend. This does not strike me as a recipe for inflation.