Reads like inflation fears are still there which should temper growth initiatives:

China economy faces downward risks in 2012

Feb 1 (Reuters) — China’s economy faces downward risks in 2012, as weakening external demand cuts into growth of the country’s export sector, the Finance Minister Xie Xuren said in remarks published on Wednesday.

He also said inflationary pressures in China remain strong as international markets are awash with cash, which has helped push up global commodity prices.

“There exists some downward pressure for the economic growth. As the external demand is now fading clearly, Chinese exporters are facing increasing difficulties,” Xie said in an article published in the ruling Communist Party’s mouthpiece magazine, Seeking Truth, which was posted on the central government website, www.gov.cn.

China’s economy, which grew at its weakest pace in 21/2 years in the latest quarter, looks to be heading for an even sharper slowdown in coming months, although an official survey of purchasing managers showed a slight upturn in factory production in January.

Xie also emphasized the important role of fiscal policy in maintaining China’s steady and relatively fast economic growth and said Beijing would continue to implement a proactive fiscal policy this year.

China’s fiscal deficit and government debt ratio, both of which remain within a safe and comfortable zone, are expected to give much scope for the government to keep its proactive fiscal policy, Xie added.

China’s nationwide fiscal revenues jumped 25.8 percent to a record high of 10.37 trillion yuan in 2011, leaving the country with a fiscal deficit of 519 billion yuan, lower than the budgeted 900 billion yuan.

“It is necessary and also possible for us to continue to implement a proactive fiscal policy,” he said. Xie also said that his ministry would provide more fiscal support to small to mediumsized enterprises and step up efforts to cut taxes for some selected sectors to restructure the economy away from exports and towards domestic consumption. “We will further improve tax cut policies in some areas to promote the development of enterprises and boost household consumption,” he added. Beijing has unveiled a slew of tax breaks to help cashstrapped small firms cope with rising costs and has also allowed them to issue more bonds and tap other sources of financing to ease the funding squeeze. The finance ministry also vowed to guarantee enough funding for key construction projects in the 12th five year plan period. Chinese Premier Wen Jiabao also said at a state council meeting on Tuesday that the central government would back funding to major projects already under way to ensure steady growth in investments.

China 2012 Budget Deficit May Rise Slightly

Feb 1 (Bloomberg) — China’s budget deficit may rise slightly or be almost unchanged this year from 2011, Gao Peiyong, a researcher with the Chinese Academy of Social Sciences, wrote in a commentary in today’s People’s Daily.

China may control fiscal expansion this year as maintaining consumer prices is a main problem for the country, Gao wrote

China may cut tax, rather than increase spending to continue conducting positive fiscal policies, according to Gao.

2012 Economic Fundamentals Remain Sound

Feb 1 (Bloomberg) — China’s economic fundamentals remain sound and the country has some advantages that will promote development this year, Finance Minister Xie Xuren wrote in Qiushi article posted on the central government’s website today.

China has “huge” domestic demand potential, Xie writes

China still faces downward pressure on economic growth, “relatively large” inflationary pressure and potential economic and financial risks, Xie writes

China’s deficit rate and debt rate are in a “safe range,” Xie writes

China Says it Will Implement Proactive Fiscal Policy This Year

Feb 1 (Yonhap) — China said Wednesday it will implement a proactive fiscal policy this year in a bid to drive up growth amid growing signs of a global economic slump.

Chinese Minister of Finance Xie Xuren, said in a statement that the government will use financial functions to maintain stable and rapid economic development in China.

China’s economic growth slowed last year, with its gross domestic product growing 8.9 percent on-year in the fourth quarter, slowing from 9.1 percent in the third quarter and 9.5 percent in the second quarter.

Over the course of the year, China’s economy expanded 9.2 percent in 2011 from a year earlier, down from 10.3 percent on-year growth in 2010.

Xie noted that China’s economy is facing downward pressure stemming from external shocks.

“The country’s exports are facing increasing difficulties, affected by significantly weakening external demand,” he said. “New drivers for economic growth need to be developed.”

The country’s export growth has begun slowing on falling global trade.

With global economic uncertainty lingering, including the European fiscal crisis, China has been looking to transform itself into a consumption-oriented economy by raising domestic demand.

Good report!
Additional notations below:

Karim writes:
U.S. GDP growth in Q4 a bit weaker than expected at 2.8%

Perhaps the FOMC had word of this, explaining the unexpected dovishness?

1.9% of that growth accounted for by inventories. Other contributions: (consumer spending 2%, fixed investment 0.4%, government spending -0.9%, net exports -0.1%).

Rebuilding post earthquake supply lines probably now complete.
Govt spending continues weak, as revenues increase some and the federal deficit falls some.
Imports rise quickly with any increase in consumer spending.

In growth terms: (consumer spending 2%, fixed investment 3.3%, government spending -4.6%, exports 4.7% and imports 4.4%).

So stripping away inventories, growth was below trend. Plus savings rate fell back to 3.7% from 3.9%.

Domestic savings down with spending up indicates increasing consumer debt.
The question is whether this is ‘wanted’ as per increased desires to buy on credit,
or because the decline in govt deficit spending ‘forced’ more consumer debt for ‘essentials’

And, core PCE slowed from 2.1% to 1.1%.

Also explains FOMC dovishness as they see risk as asymmetrical, fearing deflation more than inflation.

In sum, will keep QE3 talk very much alive

And somewhat moot, even as Q1 GDP forecasts are being revised down some, as most don’t think QE matters much for the real economy.

What’s becoming understood is that while there is ‘more the Fed can do’
for all practical purposes there is nothing they can do to further support the real economy.

Euro money and lending data shockingly weak in December.

Might partially explain how some banks apparently got the balance sheet room to buy more national govt debt?

In particular, record single month decline in lending to the non-bank private sector (74bn). Of that, 37bn decline in lending to non-financial corporates and 8bn drop in lending to households.

This should be very supportive of additional ECB rate cuts over the next few months.

Preface. I generally subscribe to the view that in free currencies, deficits are mostly self-funding, and ‘enormous’ deficits needn’t be accompanied by higher yields. Government builds a bridge, pays the bridgebuilder, who pays the grocer, who eventually either buys the Treasury or deposits in a bank whose reserves are fungible vs T-bills via the intermediating Fed. Government dissavings and private sector savings are equal and offsetting, as long as the Central Bank has a working spreadsheet and an interest rate target. Yields are just a function of duration needs of savers vs borrowers, but the AMOUNTS always match up. Likewise, I don’t believe that the creation of bank reserves is inflationary or hyper-inflationary; bank lending is capital – not reserve – constrained. Loan officers don’t check the vaults. There is always enough. I continue to marvel at the armies of deficit vigilantes who take aim at Treasuries and JGBs, armed with Gold Standard thinking or even the latest Reinhart/Rogoff, only to retreat 2-3 year later. It didn’t work shorting US Treasuries in 2009-2010 for the ‘money supply’ or ‘deficit spike,’ and that roadside is stacked with corpses. Even the Home Run deficit vigilante hitters who nailed Europe this year (and Europe is, for now, operating as a quasi-Gold standard and an entirely different set of risks) offset those gains with losses betting the other way on the US, UK, and Japan. It’s evident in the returns.

My proposals remain:

1. A full FICA suspension:

The suspension of FICA paid by employees restores spending which supports output and employment.
The suspension of FICA paid by business helps keep costs down which in a competitive environment lowers prices for consumers.

2. $150 billion one time distribution by the federal govt to the states on a per capita basis to get them over the hump.

3. An $8/hr federally funded transition job for anyone willing and able to work to assist in the transition from unemployment to private sector employment.

Call me an inflation hawk if you want. But when the fiscal drag is removed with the FICA suspension and funds for the states I see risk of what will be seen as ‘unwelcome inflation’ causing Congress to put on the brakes long before unemployment gets below 5% without the $8/hr transition job in place, even with the help of the FICA suspension in lowering costs for business.

It’s my take that in an expansion the ‘employed labor buffer stock’ created by the $8/hr job offer will prove a superior price anchor to the current practice of using the current unemployment based buffer stock as our price anchor.

The federal government caused this mess for allowing changing credit conditions to cause its resulting over taxation to unemploy a lot more people than the government wanted to employ. So now the corrective policy is to suspend the FICA taxes, give the states the one time assistance they need to get over the hump the federal government policy created, and provide the transition job to help get those people that federal policy is causing to be unemployed back into private sector employment in a more orderly, more ‘non inflationary’ manner.

I’ve noticed the criticism the $8/hr proposal- aka the ‘Job Guarantee’- has been getting in the blogosphere, and it continues to be the case that none of it seems logically consistent to me, as seen from an MMT perspective. It seems the critics haven’t fully grasped the ramifications of the recognition of the currency as a (simple) public monopoly as outlined in Full Employment AND Price Stability and the other mandatory readings.

So yes, we can simply restore aggregate demand with the FICA suspension and funds for the states, but if I were running things I’d include the $8 transition job to improve the odds of both higher levels of real output and lower ‘inflation pressures’.

Also, this is not to say that I don’t support the funding of public infrastructure (broadly defined) for public purpose. In fact, I see that as THE reason for government in the first place, and it should be determined and fully funded as needed. I call that the ‘right size’ government, and, in general, it’s not the place for cyclical adjustments.

4. An energy policy to help keep energy consumption down as we expand GDP, particularly with regard to crude oil products.

Here my presumption is there’s more to life than burning our way to prosperity, with ‘whoever burns the most fuel wins.’

Perhaps more important than what happens if these proposals are followed is what happens if they are not, which is more likely going to be the case.

First, given current credit conditions, world demand, and the 0 rate policy and QE, it looks to me like the current federal deficit isn’t going to be large enough to allow anything better than muddling through we’ve seen over the last few years.

Second, potential volatility is as high as it’s ever been. Europe could muddle through with the ECB doing what it takes at the last minute to prevent a collapse, or doing what it takes proactively, or it could miss a beat and let it all unravel. Oil prices could double near term if Iran cuts production faster than the Saudis can replace it, or prices could collapse in time as production comes online from Iraq, the US, and other places forcing the Saudis to cut to levels where they can’t cut any more, and lose control of prices on the downside.

In other words, the risk of disruption and the range of outcomes remains elevated.

Another well stated piece from John Carney on the CNBC website:

Modern Monetary Theory and Austrian Economics

By John Carney

Dec 27 (CNBC) — When I began blogging about Modern Monetary Theory, I knew I risked alienating or at least annoying some of my Austrian Economics friends. The Austrians are a combative lot, used to fighting on the fringes of economic thought for what they see as their overlooked and important insights into the workings of the economy.

Which is one of the things that makes them a lot like the MMT crowd.

There are many other things that Austrian Econ and MMT share. A recent post by Bob Wenzel at Economic Policy Journal, which is presented as a critique of my praise of some aspects of MMT, actually makes this point very well.

The MMTers believe that the modern monetary system—sovereign fiat money, unlinked to any commodity and unpegged to any other currency—that exists in the United States, Canada, Japan, the UK and Australia allows governments to operate without revenue constraints. They can never run out of money because they create the money they spend.

This is not to say that MMTers believe that governments can spend without limit. Governments can overspend in the MMT paradigm and this overspending leads to inflation. Government financial assets may be unlimited but real assets available for purchase—that is, goods and services the economy is capable of producing—are limited. The government can overspend by (a) taking too many goods and services out of the private sector, depriving the private sector of what it needs to satisfy the people, grow the economy and increase productivity or (b) increasing the supply of money in the economy so large that it drives up the prices of goods and services.

As Wenzel points out, Murray Rothbard—one of the most important Austrian Economists the United States has produced—takes exactly the same position. He says that governments take “control of the money supply” when they find that taxation doesn’t produce enough revenue to cover expenditures. In other words, fiat money is how governments escape revenue constraint.

Rothbard considers this counterfeiting, which is a moral judgment that depends on the prior conclusion that fiat money isn’t the moral equivalent of real money. Rothbard is entitled to this view—I probably even share it—but that doesn’t change the fact that in our economy today, this “counterfeiting” is the operational truth of our monetary system. We can decry it—but we might as well also try to understand what it means for us.

Rothbard worries that government control of the money supply will lead to “runaway inflation.” The MMTers tend to be more sanguine about the danger of inflation than Rothbard—although I do not believe they are entitled to this attitude. As I explained in my piece “Monetary Theory, Crony Capitalism and the Tea Party,” the MMTers tend to underestimate the influence of special interests—including government actors and central bankers themselves—on monetary policy. They have monetary policy prescriptions that would avoid runaway inflation but, it seems to me, there is little reason to expect these would ever be followed in the countries that are sovereign currency issuers. I think that on this point, many MMTers confuse analysis of the world as it is with the world as they would like it to be.

In short, the MMTers agree with Rothbard on the purpose and effect of government control of money: it means the government is no longer revenue constrained. They differ about the likelihood of runaway inflation , which is not a difference of principle but a divergence of political prediction.

This point of agreement sets both Austrians and MMTers outside of mainstream economics in precisely the same way. They appreciate that the modern monetary system is very, very different from older, commodity based monetary systems—in a way that many mainstream economists do not.

In MM, CC & TP, I briefly mentioned a few other positions on the economy MMTers tend to share. Wenzel writes that “there is nothing right about these views.”

I don’t think Wenzel actually agrees with himself here. Let’s run through these one by one.

1. The MMTers think the financial system tends toward crisis. Wenzel writes that the financial system doesn’t tend toward crisis. But a moment later he admits that the actual financial system we have does tend toward crisis. All Austrians believe this, as far as I can tell.

What has happened here is that Wenzel is now the one confusing the world as it is with the world as he wishes it would be. Perhaps under some version of the Austrian-optimum financial system—no central bank, gold coin as money, free banking or no fractional reserve banking—we wouldn’t tend toward crisis. But that is not the system we have.

The MMTers aren’t engaged with arguing about the Austrian-optimum financial system. They are engaged in describing the actual financial system we have—which tends toward crisis.

They even agree that the tendency toward crisis is largely caused by the same thing, credit expansions leading to irresponsible lending.

2. The MMTers say that “capitalist economies are not self-regulating.” Again, Wenzel dissents. But if we read “capitalist economies” as “modern economies with central banking and interventionist governments” then the point of disagreement vanishes.

Are we entitled to read “capitalist economies” in this way? I think we are. The MMTers are not, for the most part, attempting to argue with non-existent theoretical economies or describe the epic-era Icelandic political economy. They are dealing with the economy we have, which is usually called “capitalist.” Austrians can argue that this isn’t really capitalism—but this is a terminological quibble. When it comes down to the problem of self-regulation of our so-called capitalist system, the Austrians and MMTers are in agreement.

3. Next up is the MMT view (borrowed from an earlier economic school called “Functional Finance”) that fiscal policy should be judged by its economic effects. Wenzel asks if this means that this “supercedes private property that as long as something is good for the economy, it can be taxed away from the individual?”

Here is a genuine difference between the Austrians—especially those of the Rothbardian stripe—and the MMTers. The MMTers do indeed envision the government using taxes to accomplish what is good for the economy—which, for the most part, means combating inflation. They think that the government may need to use taxation to snuff out inflation at times. Alternatively, the government can also reduce its own spending to extinguish inflation.

Note that we’ve come across a gap between MMTers and Rothbardians that is far smaller than the chasm between either of them and mainstream economics, where taxation of private property and income is regularly seen as justified by the need to fund government operations. MMTers and Austrians both agree that under the current circumstances people in most developed countries are overtaxed.

4. Wenzel actually overlooks the larger gap between Austrians and MMTers, which has to do with the efficacy of government spending. Many MMTers believe that most governments in so-called capitalist economies are not spending enough. Most—if not all—Austrians think that these same government are spending too much.

The Austrian view is based on the idea that government spending tends to distort the economy, in part because—as the MMTers would agree—government spending in our age typically involves monetary expansion. The MMTers, I would argue, have a lot to learn from the Austrians on this point. I think that an MMT effort to more fully engage the Austrians on the topic of the structure of production would be well worth the effort.

5. Wenzel’s challenge to the idea of functional finance is untenable—and not particularly Austrian. He argues that the subjectivity of value means it is impossible for us to tell whether something is “good for the economy.” Humbug. We know that an economy that more fully reflects the aspirations and choices of the individuals it encompasses is better than one that does not. We know that high unemployment is worse than low unemployment. All other things being equal, a more productive economy is superior to a less productive economy, a wealthier economy is better than a more impoverished one.

Wenzel’s position amounts to nihilism. I think he is confusing the theory of subjective value with a deeper relativism. Subjectivism is merely the notion that the value of an economic good—that is, an object or a service—is not inherent to the thing but arises from within the individual’s needs and wants. This does not mean that we cannot say that some economic outcome is better or worse or that certain policy prescription are good for the economy and certain are worse.

It would be odd for any Austrian to adopt the nihilism of Wenzel. It’s pretty rare to ever encounter an Austrian who lacks normative views of the economy. These normative views depend on the view that some things are good for economy and some things are bad. I doubt that Wenzel himself really subscribes to the kind of nihilism he seems to advocate in his post.

Wenzel’s final critique of me is that I over-emphasize cronyism and underplay the deeper problems of centralized power. My reply is three-fold. First, cronyism is a more concrete political problem than centralization; tactically, it makes sense to fight cronyism. Second, cronyism is endemic to centralized government decisions, as the public choice economists have shown. They call it special interest rent-seeking, but that’s egg-head talk from cronyism. Third, I totally agree: centralization is a real problem because the “rationalization” involved necessarily downplays the kinds of unarticulated knowledge that are important to everyday life, prosperity and happiness.

At the level of theory, Austrians and MMTers have a lot in common. Tactically, an alliance makes sense. Intellectually, bringing together the descriptive view of modern monetary systems with Austrian views about the structure of production and limitations of economic planning (as well Rothbardian respect for individual property rights) should be a fruitful project.

So, as I said last time, let’s make it happen.

As if QE is an inflationary bias.
They are all clueless.

MMT to the ECB:
QE addresses the solvency issue, not ‘deflation’ or aggregate demand issues.

Bini Smaghi Says ECB Should Use QE If Deflation Risk Arises

By Gabi Thesing

Dec 23 (Bloomberg) — European Central Bank Executive Board member Lorenzo Bini Smaghi said that policy makers shouldn’t shirk from using quantitative easing if deflation becomes a danger to the euro region.

“I do not understand the quasi-religious discussions about quantitative easing,” Bini Smaghi, who will leave his post at the end of the month, said in an interview published yesterday by the Financial Times. The ECB confirmed the comments. “It is appropriate if economic conditions justify it, in particular in countries facing a liquidity trap that may lead to deflation.”

With the tools currently at their immediate disposal, including providing unlimited member bank liquidity,lowering the interbank rate, and buying euro national govt debt, the ECB has no chance of causing any monetary inflation, no matter how hard it might try. There just are no known channels, direct or indirect, in theory or practice, that connects those policies to the real economy. (Note that this is not to say that removing bank liquidity and national govt credit support wouldn’t be catastrophic. It’s a bit like engine oil. You need a gallon or two for the engine to run correctly, but further increasing the oil in the sump isn’t going to alter the engine’s performance.)

Lower rates sure doesn’t do the trick. Just look to Japan for going on two decades, the US going on 3 years, and the ECB’s low rate policies of recent years. There’s not a hint of monetary inflation/excess aggregate demand or inflationary currency weakness from low rates. If anything, seems to me the depressing effect on savers indicates low rates from the CB might even, ironically, promote deflation through the interest income channels, as the non govt sector is necessarily a net receiver of interest income when the govt is a net payer. (See Bernanke, Reinhart, and Sacks 2004 Fed paper on the fiscal effect of changes in interest rates.)

And if what’s called quantitative easing was inflationary, Japan would be hyperinflating by now, with the US not far behind. Nor is there any sign that the ECB’s buying of euro govt bonds has resulted in any kind of monetary inflation, as nothing but deflationary pressures continue to mount in that ongoing debt implosion. The reason there is no inflation from the ECB bond buying is because all it does is shift investor holdings from national govt debt to ECB balances, which changes nothing in the real economy.

Nor does bank liquidity provision have anything to do with monetary inflation, currency depreciation, or bank lending. As all monetary insiders know, bank lending is never reserve constrained. Constraints on banking come from regulation, including capital requirements and lending standards, and, of course credit worthy entities looking to borrow. With the ECB providing unlimited liquidity for the last several years, wouldn’t you think if there was going to be some kind of monetary problem it would have happened by now?

So the grand irony of the day is, that while there’s nothing the ECB can do to cause monetary inflation, even if it wanted to, the ECB, fearing inflation, holds back on the bond buying that would eliminate the national govt solvency risk but not halt the deflationary monetary forces currently in place.

So where does monetary inflation come from? Fiscal policy. The Weimar inflation was caused by deficit spending on the order of something like 50% of GDP to buy the foreign currencies demanded for war reparations. It was no surprise that selling that many German marks for foreign currencies in the market place drove the mark down as it did. In fact, when that policy finally ended, so did the inflation. And there was nothing the central bank could do with interest rates or buying and selling securities or anything else to stop the inflation caused by the massive deficit spending, just like today there is nothing the ECB can do to reverse the deflationary forces in place from the austerity measures.

So here we are, with the ECB demanding deflationary austerity from the member nations in return for the limited bond buying that has been sustaining some semblance of national govt solvency, not seeming to realize it can’t inflate with its monetary policy tools, even if it wanted to.

Post script:

The only way the ECB could inflate would be to buy dollars or other fx outright, which it doesn’t do even when it might want a weaker euro, as ideologically they want the euro to be the reserve currency, and not themselves build fx reserves that give the appearance of the euro being backed by fx.

How High Should Taxes Get on the Wealthy?

By John Carney

Good to see John Carney invoking MMT again!

My conclusion would have been with today’s shortage of aggregate demand we are grossly over taxing for inflation prevention, and so, a FICA suspension is the way to go vs a tax cut for the rich.

But it wasn’t my story.

;)

Seems the logical consequence of hair cutting Greek debt and announcing it may happen to other member nations?

That said, would not surprise me to soon be hearing hints of something like:
‘ECB bond buying not necessarily inflationary if combined with austerity’ coming out of Germany,
triggering a massive ‘relief rally’ that will last until the reality of the austerity part sinks (syncs) in,
as the 10th plague infects the German bonds markets.

*ECB’S STARK SAYS DEBT CRISIS SPREADING TO ‘CORE’ COUNTRIES
*ECB’S STARK SAYS DEBT TOLERANCE IN EUROPE IS DECLINING
*ECB’S STARK SAYS INVESTORS ARE REASSESSING SOVEREIGN DEBT

Good to see Dirk at Goldman is pretty much spot on:

German Economic Commentary : Chancellor Merkel not keen on more a proactive ECB stance

Published November 18, 2011

Chancellor Merkel gave a speech in Berlin yesterday where her main message with respect to stabilisation measures was essentially: No! Merkel rejected the introduction of Eurobonds but also any commitment from the ECB’s side to be the lender of last resort for Euro-zone governments.

There are several arguments the German government/Bundesbank are putting forward against a more pro-active stance of the ECB. First, a more pro-active role would not be in accordance with the treaties. Second, it would create moral hazard as it would reduce the incentive for governments to consolidate and reform. Third, debt monetisation, sovereign debt purchases by the ECB, leads to inflation. The latter argument was echoed by the chairman of the council of economic experts Franz, who said in an interview with FAZ newspaper that debt monetisation is a “deadly sin” for a central bank.

These are valid arguments, but only up to a point. In particular the worries about the inflationary impact of debt monetisation are exaggerated. Sovereign debt purchases of a central bank do not necessarily lead to inflation (see the example of Japan, although it can, see the example of Zimbabwe). It can lead to inflation if these purchases are used to finance an expansionary fiscal policy that will lead to strong growth and demand outpacing supply such that price setters will increase their prices. Fiscal policy, however, will be quite restrictive in the Euro-zone in the coming years. Italy, for example, aims at tightening fiscal policy by almost 3% next year on our estimate (we calculate this as the change in the structural primary fiscal balance). And while it remains to be seen whether the fiscal targets will be met, it is a safe bet that fiscal policy will not be expansionary in the Euro-zone for quite some time.

It can also lead to inflation if there is an excessive debt overhang, i.e. the fiscal position of a country is clearly unsustainable. Put differently the expansion of the monetary side is, even in the long run, not backed by a similar expansion of the real side of the economy. As we have argued in the past we see this only as a remote risk.

What the ECB is currently doing under its SMP is essentially swapping one savings instrument (peripheral sovereign debt) for another (cash) as private sector investors, for various reasons, no longer want to hold peripheral debt. But this has no inflationary implications unless one assumes that investors are spending the cash thereby stimulating demand which then leads to inflation. But these investors are not holding cash because they want to increase their spending, but because they think, rightly or wrongly, that cash is more rewarding from an investment point of view.

There are no easy choices and it would have been, no doubt, better if the ECB had never got in the position it is in now. But the current situation demands a careful weighing of the risk involved with any decision taken. The inflationary risk thereby seems to be getting an unduly high weight in the consideration of German policy makers.

Dirk Schumacher

And this Fed fears deflation a lot more than inflation:

• We see signs that the upside inflation surprises of 2011 have ended. Our new statistical summary of the price components of business surveys such as the ISM, Philly Fed, and NFIB points to decelerating inflation. In addition, our unweighted CPI diffusion index, which measures the breadth of price changes across 178 detailed price categories, fell to its lowest level since late 2010.

Inflation has been above our expectations in 2011, but we expect a substantial part of this surprise to reverse and see core inflation clearly below the Fed’s “mandate-consistent” level of 2% or a bit less by the end of 2012. The reasons are straightforward. There is still a large amount of slack in the US economy; nominal wage inflation remains very low; and much of the inflation pickup of 2011 can be traced to temporary factors such as short-term commodity price pass-through and upward pressure on motor vehicle prices in the wake of the Japanese earthquake. (We do not expect a full reversal of the core inflation pickup because the increase in rent inflation is likely to be more persistent.)

The recent inflation data have started to look more consistent with our view of moderating core inflation. The consumer price index (CPI) excluding food and energy has risen at an annualized rate of just 1.2% over the past two months, the lowest rate since December 2010 Statistically based measures of core inflation such as the Cleveland Fed’s weighted-median and 16% trimmed-mean CPI send a similar message.

Our unweighted CPI diffusion index is also starting to look a bit more benign again. It is constructed by seasonally adjusting all 178 individual CPI categories for which we have sufficient data, calculating the month-to-month change, and then reporting the percentage of categories showing price increases plus half the percentage showing no change. That is, values above 50 indicate that more categories are seeing price increases than decreases; the higher above 50, the greater the breadth of price increases relative to price decreases. (We perform our own seasonal adjustment because the Labor Department only provides seasonally adjusted CPI data for a subset of product categories.) Exhibit 1 below shows our diffusion index. While it is still clearly above the levels of 2009 and 2010, the October 2011 reading was the lowest since November 2010.

Exhibit 1: CPI Diffusion Index Has Started to Slow

To gain more insight into future inflation trends, we have constructed a new measure that summarizes the inflation signal from various business surveys. Specifically, we calculated the first principal components of the price-related questions in the monthly ISM, Chicago PMI, Philly Fed, NFIB, Kansas City Fed, and Richmond Fed business surveys. These questions refer to prices paid, prices received, or wages and salaries and are generally reported as the difference between the percentage of respondents saying that prices rose in the survey month and the percentage saying that prices fell. (Focusing only on prices paid or prices received indexes does not make a significant difference to the results.)

The results are shown in Exhibit 2 below. In general, our business survey indicator of inflation tracks the ups and downs of the core PCE index–the Fed’s favorite measure of underlying inflation–reasonably well. After a significant acceleration in early 2011, the indicator has declined notably in recent months and is now consistent with a deceleration in core PCE inflation from the recent 2%+ level to somewhere closer to 1.5%. This is also consistent with our forecast that inflation will slow over the next year.

Exhibit 2: Business Survey Inflation Shows Recent Deceleration

Now on Huffington Post:

It must be impossible for the Fed to create inflation

Warren will be on the Peter Schiff Show tomorrow, 11/17/2011, at 10:33 am EST.

Find your local station here, to listen live.

Or stream here.

Otherwise this loop will play for 24 hours after the conclusion of the show.

Topic:

>   
>   As for topics, I thought we could talk about your piece on inflation failing to manifest
>   despite the dire warnings.
>   

As previously discussed, GDP looks to be growing sequentially, and should do fine next year if fiscal policy doesn’t tighten.

But still not so good for people working for a living, pretty good for corporate earnings.

And risks remain- Europe, China, Super Committee, etc. etc.

And look for a relief rally if Europe all agrees the ECB writes the check,
followed by a sell off due to the austerity that accompanies it.

Karim writes:

Hardly an hour goes by without some pundit pushing the possibility of some kind of run away inflation, with Zimbabwe and Weimar rolling off the tongues of ordinary Americans everywhere. And Congressman and candidates of all persuasions continuously lambaste the Fed for debasing the currency.

There’s no question the Fed has been trying to reflate, particularly with regard to housing. They were not going to make the mistake Japan made, so they rapidly dropped the fed funds rate to near 0%, provided unlimited bank liquidity, and then went on to buy $trillions of US government securities in an attempt to support demand and prices by adding more liquidity and further bringing down long term interest rates and mortgages. The stated and obvious intent has been to do everything they can to support a private sector credit expansion that would support prices and the aggregate demand needed to reduce unemployment.

For all practical purposes the Fed has done it all. And yet unemployment remains at depression levels of over 9% (and over 16% the way it used to be calculated not long ago) and the only thing keeping what’s called ‘inflation’ over 1% is a foreign monopolist supporting the price of crude oil.

So if inflation is this ominously lurking around every corner that requires eternal vigilance to keep from suddenly rearing its ugly head, why have all the Fed’s horses and all the Fed’s men not been able to inflate again? And why would anyone still think they can? I mean, we’re talking about college graduates with advance degrees and resources and power up the gazoo doing everything they can to reflate, and still failing after 3 long years? Not to mention the same in Japan for going on 20 years, where they have college grads with advanced degrees as well (though pretty much from the same schools).

Maybe this inflation thing is harder to get going than it looks? And what did go on in the German Wiemar republic, where if you parked a wheelbarrow full of money thieves would take the wheelbarrow and leave the money? Turns out it was those pesky war reparations that caused government deficit spending to soar to something like 50% of GDP annually, with most of that whopping deficit spending used to sell the German currency and buy foreign currency to pay their war reparations. As expected, that drove their currency down the rat hole in short order, and kept driving it down, causing that famous bout of hyper inflation that didn’t end until that policy ended. And when all that ended and policy changed the inflation stopped dead in its tracks. In one day. So how about Zimbabwe? Turns out they had a tad of civil unrest that dropped their productive capacity by about 80%, but government spending stayed high and too much spending power with too few goods and services for sale drove prices through the roof. Not to mention rumors of insiders using the local currency to buy foreign currencies for personal gain (sound familiar).

Applying this to the US to replicate the Wiemar inflation Congress would have to increase the deficit to about $8 trillion a year and then sell those dollars continuously in the market place, using them to buy the likes of yen, euro, and pounds. And replicating Zimbabwe would mean some kind of disaster that wiped out 80% of our real productive capacity and then continuing to spend federal dollars as if that never happened.

But note that it turns out these examples of hyper inflation are traced back to wildly excessive govt. deficit spending, and not actions by the Central Banks. And, in fact, from what I’ve seen those kinds of levels of deficit spending always cause inflation, no matter what the Central Bank does. For example, deficit spending and indexation of prices paid by government to various measures of inflation propagated all the great Latin American inflations of the relatively recent past, even as the Central Banks desperately hiked rates, didn’t buy securities, and, in general, did all they could to promote price stability.

China gives us an interesting contemporary data point to consider. Deficit spending in China has been running over 20% per year when you include state lending to state owned enterprises, local governments, and other entities where repayment isn’t a factor, making that lending, for all practical purposes, pretty much the same as deficit spending. The only time the US deficit spending got that high, with pretty much the same growth rates, was during World War II. And while considered high, China’s inflation seems to have peaked at about 6%, a far cry form hyper inflation, also, interestingly, much like the US during World War II. And note during World War II, the Fed was entirely accommodative, much like the the Fed is today, buying Treasury securities to keep long term rates low.

What all this tells me is that run away inflation, whatever that might mean, isn’t something hiding around every corner waiting to pounce. In fact, it takes a lot of work to get there, and not from the Fed, but from Congress. And not just what we’d call high levels of deficit spending, but ultra high levels of deficit spending.

I have no fear whatsoever of the Fed causing inflation. In fact, theory and evidence tells me their tools more likely work in reverse, due to the interest income channels. That’s because when they lower rates, they are working to remove net interest income from the private sector, and when they buy US Treasury securities (aka QE/ quantitative easing) they remove even more interest income from the economy. Remember that $79 billion in QE portfolio profits the Fed turned over to the Treasury last year? Those dollars would have otherwise remained in the economy.

So what’s the fundamental difference between what the Fed and can do and what Congress can do? The Fed can’t create net financial assets because they only buy, loan, and otherwise traffic in financial assets. Buying a bond or any other security only exchanges one financial asset for another and therefore doesn’t change the nominal (dollar) wealth of the economy. When the Fed buys a security, that security is no longer held by the economy. The Fed gets the security and the economy gets an equal dollar balance in a Fed account. The exchange is done at market prices so for all practical purposes it’s a equal exchange.

When Congress spends, however, it usually buys real goods and services, and not securities and other financial assets. So when the exchange takes place, Congress gets the real goods and services, which are not financial assets, and the economy gets dollar balances at the Fed, which are financial assets. So spending by Congress adds financial assets to the economy, to the penny, making it very different from what the Fed does.

And note that when the economy buys Treasury securities, all that happens is that the dollar balances the economy has at the Fed in what are called ‘reserve accounts’ get move to dollar balances in what are called ‘securities accounts’ at the Fed. Dollars in securities accounts and reserve accounts are all dollar financial assets. So shifting back and forth doesn’t change the dollar nominal wealth of the economy.

In conclusion, theory and evidence tell me it’s impossible for the Fed to create inflation, no matter how much it tries. The reason is because all the Fed does is shift dollars from one type of account to another, never changing the net financial assets held by the economy. Changing interest rates only shifts dollars between ‘savers’ and ‘borrowers’ and QE only shifts dollars from securities accounts to reserve accounts. And so theory and evidence tells us not to expect much change in the macro economy from these primary Fed tools, making it impossible for the Fed to create inflation.

Post Script:

And don’t be fooled by arguments centering around inflation expectations theory. That does’t hold any water either, and under close examination gets no support from theory or evidence. The only support it gets is from fundamentally flawed assumptions, which I’ll save for another discussion.

ECB’s Weidmann Spoils The Party: Says Leveraging EFSF Violation Of EU Treaty, Warns Of Hyperinflation

By Tyler Durden

November 8 (Zero Hedge) — Trust the Germans in the ECB (those who have not yet resigned that is) in this case Jesn Weidmann, to come in and spoil the party:

Weidmann, speaking in Berlin, says hyperinflation shows why monetizing debt wrong

Prohibition on monetary financing an important achievement.

Euro treaty rightly forbids monetary financing

Stable prices should be key goal of ECB

Leveraging EFSF with currency reserves prohibited

Says monetary analysis may gain importance at ECB

And for all our MMT friends:

“One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, in colloquial terms also known as the financing of public debt via the money printing press:” Weidmann

Prohibition of monetary financing in the euro area “is one of the most important achievements in central banking” and “specifically for Germany, it is also a key lesson from the experience of hyperinflation after World War I”

Summary from Bloomberg

The news flow from last week was so voluminous it was nearly impossible to process. For good measure I want to start today’s commentary with a simple recap of what happened.

On the negative side -

· Greece called a referendum and threw bailout plans up in the air taking Greek 2yrs from 70% to 90% or +2000bps.
· Italian 10yr debt collapsed 40bps with spreads to Germany out 70bps. The moves were far larger in the 2yr sector.
· France 10y debt widened 25bps to Germany. At one point spreads were almost 40 wider.
· Italian PMI and Spanish employment data were miserable.
· German factory orders plunged 4.3 percent on the month.
· The planned EFSF bond for 3bio was pulled.
· Itraxx financials were +34 while subs were +45.
· Draghi predicted a recession for Europe along with disinflation.
· The G20 was flop – there was no agreement on IMF involvement in Europe.
· The US super committee deadline is 17 days away with no clear agreement.
· The 8th largest US bankruptcy in history took place.
· US 10yr and 30yr rallied 28bps, Spoos were -2.5%, the Dax was -6% and EURUSD was -3%.
· German CDS was up 16bps on the week.

On the positive side -

· The Fed showed its hand with tightening dissents now gone and an easing dissent in place.

Too bad what they call ‘easing’ at best has been shown to do nothing.

· The Fed’s significant downside risk language remained intact.

Downside risks sound like bad news to me.

· In the press conference Ben teed up QE3 in MBS space.

Which at best have been shown to do little or nothing for the macro economy.

· US payrolls, claims, vehicle sales and productivity came in better than expected.

And the real output gap if anything widened.

· S&P earnings are coming in at +18% y/y with implied corporate profits at +23 percent q/q a.r.

Reinforces the notion that it’s a good for stocks, bad for people economy.

· Mortgage speeds were much faster than expectations suggesting some easing refi pressures.

And savers holding those securities saw their incomes cut faster than expected.

· The ECB cut 25bps and indicated a dovish forward looking stance.

Which reduced euro interest income for the non govt sectors

· CME Margins were reduced.

Just means volatility was down some.

· There was a massive USDJPY intervention which may be a precursor to a Swiss style Japanese policy easing.

Which, for the US, means reduced costs of imports from Japan, which works against US exports, which should be a good thing for the US as it means for the size govt we have, taxes could be lowered to sustain demand, but becomes a bad thing as our leadership believes the US Federal deficit to be too large and so instead we get higher unemployment.

· The Swiss have indicated they want an even weaker CHF – possibly EURCHF 1.40.

When this makes a list of ‘positives’ you know the positives are pretty sorry

· The Aussies cut rates 25bps

Cutting net interest income for the economy.

Reads like the inflation problem was worse then most thought, and that a hard landing might still actually be happening. No way to actually tell in real time.

With China a first half/second half story, as previously discussed, January will bring a fresh slug of new govt. lending/spending that should at least moderate any fall that’s in progress.

However, if the anti inflation fiscal policies continue, and spending/lending is materially down from last year, the weakness should persist and potentially get a lot worse.

Property Prices Collapse in China. Is This a Crash?

By Gordon Chang

November 6 (Forbes) — Residential property prices are in freefall in China as developers race to meet revenue targets for the year in a quickly deteriorating market. The country’s largest builders began discounting homes in Shanghai, Beijing, and Shenzhen in recent weeks, and the trend has now spread to second- and third-tier cities such as Hangzhou, Hefei, and Chongqing. In Chongqing, for instance, Hong Kong-based Hutchison Whampoa cut asking prices 32% at its Cape Coral project. “The price war has begun,” said Alan Chiang Sheung-lai of property consultant DTZ to the South China Morning Post.

More of the blind leading the blind. The one thing they all agree on, at great expense to global well being, is the budget deficits are all too large and the need for shared sacrifice and all that.

No chance for anything constructive to come out of any of this.

And these masters of their money machines don’t even know how to inflate, as they all desperately try to inflate with their versions of quantitative easing, which, functionally, is just another demand draining tax.

*DJ Merkel, Obama Discussed How To Boost EFSF Firepower Without ECB
*DJ Obama To Merkel: We Are Totally Invested In Your Success – Source
*DJ Geithner, Schaeuble May Meet To Discuss IMF Role In Euro Crisis -Source

I’ve been reading up some on ECB capital.

Seems a minimum capital level for the ECB is not specified.

However, the ECB distributes profits ultimately to the national govts.

And that ECB losses are ultimately the responsibility of the national govts.

That’s why, faced with potential losses, the ECB has required the national central banks to advance additional capital to the ECB.

However, in the event of losses, the ECB is not required to call for capital from its members, but as a matter of policy the ECB has called for capital from its members when it deemed the risk of losses had risen.

So while the ECB, like the Fed, can, operationally, allow its capital to go negative without operational consequence. The ECB, unlike the Fed, looks to keep it’s capital positive by requiring contributions from its members.

This therefore means, for example, that should the ECB realize losses on its Greek bonds, it will demand additional capital from the national central banks/national govs. which will further erode their solvency.

The reason for this seems to be the notion that ECB losses left as negative capital would otherwise be inflationary.