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Archive for February 21st, 2008

More on ‘now vs the 70′s’

Posted by Sada Mosler on 21st February 2008

Comments people emailed me and my responses:

Bob Hart wrote:

This graph supports your statement below:
Prices fell from a high of maybe $40 per barrel to the $10-15 range for the next two decades

2008-02-21 Crude Oil Production OPEC Countries


“So, there is nothing the US can do to keep core inflation in check? Only the Saudis (and other oil producers) control US inflation?”

In this case, yes. If the Saudis keep hiking cpi goes up and an inflation begins via the various channels that connect energy with other prices. And in this case exacerbated by our pension funds.

Randall Wray wrote:

right: previous high inflations have always been: energy, food, and shelter costs. I haven’t looked at shelter costs this time around.

Haynes wrote:

Great piece. I’ve been thinking along the same lines over the last few weeks. I wish I had been a lot shorter the long end but think that trade still makes sense, especially given future deficits over the next 3-5 years. Having been born in the 1980s and not lived through oil embargos, stock market stagnation and hyper inflation, I am not exactly sure what the play is over the near-term and longer term. If you were to set up a portfolio that couldn’t be changed over the next 3 yrs / 5yrs / 10yrs what do you think the mix should be?

I like AVM’s current mortgage construction: buy FN 5′s versus tailored swap at LIBOR plus 25 basis points with a ‘free’ embedded put. Put it on and sit tight for Fed hikes. Worst case you get LIBOR plus 25.

Call your AVM salesman ASAP before the spread vanishes!!!

Do you buy TIPS / Broad based commodities indices (DJP) / Gold / Stocks / short end / long end?

‘Raw’ TIPS imply a low real rate. If the Fed decides to rais the real rate, you lose.

You could do a 10 year break even bit, especially in Japan, but I like the mortgage trade better.

Think that you could get killed owning bonds but input prices have already run so much its hard to buy commodities in a potentially declining demand environment. Do you buy stocks hoping they simply stay inline with inflation or do you just hold cash?

In the medium- and long-term the S&P will probably more than keep up with inflation, but help to get the right one and to get the right entry point.

Thanks for the help. I know you are busy but any insight would be much appreciated. thanks.

Philip wrote:

I agree entirely with the view that the 1970s was a question of energy prices, a supply-side phenomenon rather than anything else. The implications for policy are important; we might produce a problem where it does not exist if policy is predicated on the wrong interpretation of the problem.

Posted in Fed, Oil, USA | 4 Comments »

Now versus the 1970s

Posted by Sada Mosler on 21st February 2008

Looks very much like the 1970′s to me.

Yes, the labor situation was different then – strong unions due to strong businesses with imperfect competition, umbrella pricing power and the like.

But it was my take then that inflation was due to energy prices, and not wage pressures. Inflation went up with oil leading throughout the 1970′s and the rate of inflation came down only when oil broke in the early 1980′s, due to a sufficiently large supply response. It was cost push all the way, and even the -2% growth of 1980 didn’t do the trick. Nor did 20%+ interest rates. Inflation came down only after Saudi Arabia, acting then as now as swing producer, watched its output fall to levels where it couldn’t cut production any more without capping wells, and was forced to hit bids in the crude spot market. Prices fell from a high of maybe $40 per barrel to the $10-15 range for the next two decades, and inflation followed oil down. And when demand for Saudi production recovered a few years ago they quickly re-assumed the role of swing producer and quietly began moving prices higher even as they denied and continue to deny they are acting as ‘price setter’ with inflation again following.

And both then and now everything is ultimately ‘made out of food and energy’ and hikes in those costs work through to everything else over time.

There are differences between then and now. A new contributor to inflation this time around are our own pension funds, who have been allocating funds to a passive commodity strategies as an ‘asset class.’ This both drives up costs and inflation directly, and adds to aggregate demand (also previously discussed at length).

Also different is that today we’ve outsourced a lot of the labor content of our gdp, so I suggest looking to import prices of high labor content goods and services as a proxy for real wages. And even prices from China, for example, have gone from falling to rising, indicating an inflation bias that corresponds to the wage increases of the 70′s.

Costs of production have been going up as indicated anecdotally by corporate data and by indicators such as the PPI and its components. These costs at first may have resulted in some margin compression, but recent earnings releases seem to confirm pricing power is back and costs are pushing up final prices, even as the US GDP growth slows.

US policies (discussed in previous posts) have contributed to a reduced desire for non residents to accumulate $US financial assets. This plays out via market forces with a $US weak enough to entice foreigners to buy US goods and services, as evidenced by double digit growth in US exports and a falling trade gap. This ‘external demand’ is providing the incremental demand that helps support US gdp, and corporate margins via rapidly rising export prices.

World demand is high enough today to support $100 crude, and push US cpi towards 5%, even with US GDP running near zero.
As long as this persists the cost push price pressures will continue.

Meanwhile, markets are pricing continued ff rate cuts as they assume the Fed will continue to put inflation on the back burner until the economy turns. While this is not a precise parallel with the 1970′s, the era’s were somewhat similar, with Chairman Miller ultimately considered too soft on inflation during economic weakness. He was replaced by Chairman Volcker who immediately hiked rates to attack the inflation issue, even as GDP went negative.

Posted in Fed, Oil, USA | 2 Comments »

2008-02-21 US Economic Releases

Posted by Sada Mosler on 21st February 2008

2008-02-21 Initial Jobless Claims

Initial Jobless Claims (Feb 16)

Survey 349K
Actual 349K
Prior 348K
Revised 358K

Down a bit but lost a day in California. Chart looks like it’s drifted to a bit higher levels.

Still not recession type numbers yet, however.

2008-02-21 Continuing Claims

Continuing Claims (Feb 9)

Survey 2760K
Actual 2784
Prior 2761K
Revised 2736

Also looking like it’s moved up to higher levels, but still far from typical recession levels.

2008-02-21 Philadelphia Fed.

Philadelphia Fed. (Feb)

Survey -10.0
Actual -24.0
Prior -20.9
Revised n/a

Looks serious!  Strange that employment was up 2.5, however, and, of course, prices on the rise.

2008-02-21 Leading Indicators

Leading Indicators (Jan)

Survey -0.1%
Actual -0.1%
Prior -0.2%
Revised -0.1%

Still drifting lower, but no collapse.

Posted in Daily | No Comments »

Bloomberg: Trichet may not cut rates in 2008

Posted by Sada Mosler on 21st February 2008

Trichet May Not Cut Rates in 2008, Say Merrill, ABN

by Simon Kennedy
(Bloomberg)Erik Nielsen, Goldman Sachs’s chief European economist, disagrees. He said the ECB’s primary mandate is to preserve price stability, so it has no room to follow the Federal Reserve and the Bank of England, even as economic growth weakens. The Fed slashed its main rate by 1.25 percentage points last month, and the Bank of England cut its benchmark by a quarter point Feb. 7 for the second time in three months.

“Inflation and expectations for it are a hurdle for a cut,” Nielsen said. “Inflation is very stubborn” in Europe.

The annual pace of consumer-price increases in the euro region accelerated to a 14-year high of 3.2 percent in January, pushed above the ECB’s 2 percent limit for a fifth month by food and energy costs. Inflation in France, the euro-area’s second largest economy, accelerated in January to the fastest pace in at least 12 years, according to data released today.

US CPI is up nearly 4.5% year over year with no let up in sight, and core measures are above FOMC comfort zones and picking up steam as well.

Posted in Interest Rates | 1 Comment »