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John Silvia update on employment and inflation
John Silvia, chief economist at Wells Fargo (formerly at Wachovia), gives his update on employment and inflation outlook. John is a top macro forecaster, whom I often listen to.
Taylor rebuffs Bernanke
John Taylor thinks Bernanke misinterpreted his Taylor Rule on monetary policy…he's not happy about it. According to original Taylor Rule, the Fed should raise interest rate to 1%.
When you have a Fed that can change rule as they wish, you know more troubles are ahead.
Reinhart comments on Bernanke’s Fed
Vincent Reinhart discusses the Fed’s monetary policy outlook – Fed first need to unload its balance sheet before raising rates.
Maybe “stagflation” is for real…
Yield curve is telling a very different story than the stock market. Echoing Meltzer’s earlier piece, “Bernanke’s 70s show“, maybe stagflation is for real…reports WSJ:
Treasurys may be signaling trouble.
The market is behaving in ways that suggest investors are starting to fret over the potential for stagflation in the U.S. …
Consider the Treasury “yield curve.” It refers to the difference between short-term and long-term interest rates on U.S. Treasury debt. Typically, as the economy is expanding, this curve has an upward slope, and is usually at its steepest during the earliest stages of a recovery.
Eventually, investors anticipate the Fed will begin raising interest rates to stave off inflation. That tends to lift short-term rates, compress long-term ones, and generally flatten the curve, or even invert it if investors expect the outcome could be recession.
Lately, with the U.S. growth outlook improving, the slope of the curve hasn’t started flattening, as might be expected at this point in the recovery. Instead, it has gotten steeper.
Earlier this week, the spread between two-year and 30-year Treasury yields hit a record-wide four percentage points, notes RBS Securities. At the same time, the implied annual inflation rate over a five-to-10 year horizon, based on Treasury yields, has moved up above 3% and towards levels last seen before the Fed’s previous rate-rise cycle began in mid-2004.
Investors, in other words, don’t expect the Fed to be as aggressive as in the past in raising rates—even as they see inflation on the rise.
“I think the Fed’s credibility is in question here,” says Priya Misra, head of rates strategy at Bank of America Merrill Lynch.
Or perhaps investors simply realize the Fed has put itself between a rock and a hard place. The U.S. unemployment rate is currently 9.4%, after all. It was at 5.6% in June 2004.
In a twist, the best scenario for the U.S. now is that interest rate increases in China, Brazil and other emerging markets rein in global cost pressures, giving the Fed—and the recovery—some breathing room.
The U.S. needs strong growth more than ever, especially with limited appetite for serious fiscal overhaul, to assuage the market’s other worry: wide deficits and heavy debt.
The clock is ticking.
![[AOT]](https://si.wsj.net/public/resources/images/MI-BH984_AOT_NS_20110120183303.jpg)
America’s new export – Inflation
It’s the replay of 1H of 2008, only with more severity. If were not for Lehman’s collapse, the prices of commodities would have shot to the roof more than two years ago. Now the still-the-same super easy monetary policy made commodity prices, especially food prices, come back again, evident everywhere in the world.
(click to enlarge, source: BOE)
China just reported its latest CPI number of close to 5%, but food prices jumped over 10% year over year. The food inflation forced China’s Bureau of Statistics to adjust down the weight of food in the CPI calculation. Isn’t this ridiculous! — The government wanted to you to believe as if inflation does not exist!
At the same time, various signs show that the huge excess reserves are being gradually unleashed from banks’ balance sheets — one indicator is that the yield on junk bonds has almost reached historical lows; another sign is that banks now started to relax their lending standards to both consumers and small businesses.
What we are seeing is exactly the divergence of traditional inflation measure (CPI) and asset inflation. Let’s call it “biflation”.
(click to enlarge, source: BOE)
Ronald McKinnon, an expert of exchange rate and US dollar at Stanford University, labels inflation as America’s latest export:
What do the years 1971, 2003 and 2010 have in common? In each year, low U.S. interest rates and the expectation of dollar depreciation led to massive “hot” money outflows from the U.S. and world-wide inflation. And in all three cases, foreign central banks intervened heavily to buy dollars to prevent their currencies from appreciating.
When central banks issue base money to buy dollars, domestic interest rates are forced down and domestic inflationary pressure is generated. Primary commodity prices go up quickly because speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.
The world saw a surge in the dollar prices of primary commodity prices in 1971-73 following the Nixon shock of 1971 when the U.S. abandoned the gold standard. There was also a commodity price surge during the Greenspan-Bernanke shock of 2003-04, when the federal-funds rate was reduced to an unprecedented low of 1% followed by a falling dollar.
Now we have what one might call the Bernanke shock. The Fed has set U.S. short-term interest rates at essentially zero since September 2008, followed in 2010 by quantitative easing to drive down long-term rates. Predictably, primary commodity prices in 2009-10 surged. In 2010 alone, all items in the Economist’s dollar commodity price index rose 33.5%, while the industrial raw materials component soared a remarkable 37.4.%.
The longer-term inflationary and economic consequences over the next decade of this most recent U.S. loose money shock remain to be seen. But we can glean useful hints by looking at the aftermaths of the two earlier shocks. In the 1970s, “stagflation” (inflation combined with cyclical bouts of unemployment and wide swings in exchange rates) seemed intractable. Productivity growth in mature industrial countries fell sharply.
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The Greenspan-Bernanke interest rate shock of 2003-04, followed by a weakening dollar into the first half of 2008, created the bubble economy. Primary commodity prices began rising significantly in 2003-04, then flattened out before spiking in 2007 into the first half of 2008.
But the biggest bubble was in real estate, both commercial and residential. With low mortgage rates and no restraining regulation on mortgage quality, average U.S. home prices rose more than 50% from the beginning of 2003 to the middle of 2006. This led to an unsustainable building boom—with echoes around the world in countries such as the U.K, Spain and Ireland. The bubbles in primary commodity prices collapsed mainly in the second half of 2008. But the residue of bad debts, particularly ongoing mortgage defaults, led to the banking crisis and global downturn of 2008-09.
So what lessons can we draw from these episodes of U.S. easy money and a weak dollar for the stability of the American economy itself?
First, sharp general price increases in auction-market goods such as primary commodities or foreign exchange (i.e., a weakening dollar) is an early warning sign that the Fed is being too easy—a warning that the Fed is again ignoring as we enter 2011.
Second, beyond the rise in primary commodity prices, general price inflation in the U.S. only comes with long and variable lags. After the U.S. monetary shock, hot money flows into countries on the dollar standard’s periphery cause a loss of monetary control and general inflation to show up there more quickly than in the U.S.
In 2010, consumer price indexes shot up more than 5% in major emerging markets such as China, Brazil and Indonesia, while the consumer price index in the U.S. itself rose only 1.2%. Similarly, after the Nixon shock of 1971, there was much more explosive inflation in Japan in 1972-73 than in the U.S. But by December 1979, inflation in America’s producer and consumer price indexes was more than 13%.
China steps up its global currency move
There has been a stream of news on Chinese government's new move to make Yuan global. First, Bank of China recently allowed customers in NYC to open Yuan account; then China is set to allow its firms to trade currency swaps to hedge currency risk starting from March 1st; then foreign firms operated in China, such as McDonald, now will be allowed to issue Yuan-denominated bonds in Hong Kong. According to NYT,
Meanwhile, in Russia, Vietnam and Thailand, some cross-border trades with China can now be settled in renminbi, so that trading partners do not have to convert in and out of dollars. One pilot program lets Russian companies like Sportmaster, a retail chain based in Moscow, buy or sell goods using Chinese currency.
And in New York, the Chinese government has permitted an overseas branch of Bank of China to accept deposits in renminbi. That enables depositors outside China to bet on a currency that is widely expected to appreciate against the dollar over the next few years.
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Robert A. Mundell, a Nobel laureate economist whose research is credited with helping develop the euro, says the renminbi’s rise is all but inevitable.
“The RMB is likely to become a reserve currency in the future, even if the government of China does nothing about it,” Professor Mundell said in an e-mail response to questions. He noted that the renminbi was already a regional currency in Southeast Asia, where China had become the dominant trading partner of many countries.
If China does eventually open its capital market by eliminating currency exchange controls, he said, “the progress of the RMB as an international currency will be assured.”
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As an influence on global financial markets, the renminbi is “still a distant, distant, distant fourth,” said Albert Keidel, a China specialist at the Public Policy Institute at Georgetown University in Washington. “People are going to start holding more renminbi, but it will be at least a decade or two for it to become a leading world reserve currency.”
I expect that, in an optimistic scenario, Yuan will become fully convertible in five to ten years.
Is US manufacturing really declining?
A lot of misconceptions, a lot of wrong facts – you don't find "Made in USA" in consumer goods, but US manufacturing is everwhere in durable and capital goods. According to Jeff Jacoby of Boston Globe:
Americans make more “stuff’’ than any other nation on earth, and by a wide margin. According to the United Nations’ comprehensive database of international economic data, America’s manufacturing output in 2009 (expressed in constant 2005 dollars) was $2.15 trillion. That surpassed China’s output of $1.48 trillion by nearly 46 percent. China’s industries may be booming, but the United States still accounted for 20 percent of the world’s manufacturing output in 2009 — only a hair below its 1990 share of 21 percent.
A vast amount of “stuff’’ is still made in the USA, albeit not the inexpensive consumer goods that fill the shelves in Target or Walgreens. American factories make fighter jets and air conditioners, automobiles and pharmaceuticals, industrial lathes and semiconductors. Not the sort of things on your weekly shopping list? Maybe not. But that doesn’t change economic reality. They may have “clos[ed] down the textile mill across the railroad tracks.’’ But America’s manufacturing glory is far from a thing of the past.
The economic roots of Egypt’s revolt
Zachary Karabell analyzes the economic roots of the revolt, and compares it with China's experience:
The mass movement engulfing Egypt exposes a fact that has been hiding in plain sight: In a decade during which China has brought more people out of poverty at a faster rate than ever in human history, in a period of time where economic reform has been sweeping the world from Brazil to Indonesia, Egypt has missed out.
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The country ranks 137 in the world in per-capita income (just behind Tonga and ahead of Kirbati), with a population in the top 20. And while GDP growth for the past few years has been respectable, averaging 4%-5% save for 2009 (when all countries suffered), even that is at best middle of the pack in a period where the more competitive dynamic nations have been surging ahead.
Egypt has long been famous for crony inefficiency. Yet Hosni Mubarak was graced with nearly $2 billion in annual U.S. aid, another $5 billion from dues from the Suez Canal, and $10 billion in tourism, so he could buy off a considerable portion of the 80 million Egyptians.
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In recent years, Mr. Mubarak seemed to realize that the complete absence of economic reform wasn't tenable. He watched as China surged ahead without loosening the control of the state over political life. He made overtures to regional trade blocs. In fact, a few days before the protests erupted, Mr. Mubarak hosted the second Arab Economic, Development and Social Summit in the resort of Sharm al-Shaikh, calling for more Arab economic integration, regional transportation infrastructure and trade.
What allows China to thrive for now (and Brazil and India and Indonesia, among many others) is that its citizens believe they have some control over their material lives and a chance to turn their dreams and ambitions into reality. They have an outlet for their passions that is not determined for them, and an increasing degree of economic freedom.
The young in Egypt—two-thirds of the population is under the age of 30—believe that they have no future, and in many ways they are correct. Under Mr. Mubarak, their food and housing is subsidized and they are placed in jobs or left in unemployed limbo, not starving but without any hope of anything but years of numbing sameness.
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Meanwhile, China ignored the dialectic in the West—which placed political opening at the top of societal imperatives—and plunged into an experiment of hypercharged economic development without political change. Its phenomenal success to date is impossible to refute, just as its future course is impossible to predict.
But Egypt managed to forestall both paths, and its lesson is simple: You can have economic reform, or you can have political reform. You cannot have neither.