Saudi production increased marginally for January, and all indications are net demand is holding up at the higher prices.
While this bodes for continued price hikes, markets may have likely sold off on the news, believing the higher production is a sign of a proactive supply increase that will drive prices down.
It’s the difference between getting your offer lifted vs your bid hit. Saudi (and Russian) offers are clearly getting lifted.
♥
On Jan 5, 2008 9:40 PM, Steve Martyak wrote:
> http://www.autodogmatic.com
>
>
> also….
>
> 9/4/2006
> Cover of Business Week: How Toxic Is Your Mortgage? :.
>
> The option ARM is “like the neutron bomb,” says George McCarthy, a housing
> economist at New York’s Ford Foundation. “It’s going to kill all the people
> but leave the houses standing.”
>
> Some people saw it all coming….
>
The subprime setback actually hit about 18 months ago. Investors stopped funding new loans, and would be buyers were were no longer able to buy, thereby reducing demand. Housing fell and has been down for a long time. There are signs it bottomed October/November but maybe not.
I wrote about it then as well, and have been forecasting the slowdown since I noted the fed’s financial obligations ratio was at levels in March 2006 that indicated the credit expansion had to slow as private debt would not be able to increase sufficiently to sustain former levels of GDP growth. And that the reason was the tailwind from the 2003 federal deficits was winding down. as the deficit fell below 2% of GDP, and it was no longer enough to support the credit structure.
Also, while pension funds were still adding to demand with their commodity allocations, that had stopped accelerating as well and
wouldn’t be as strong a factor.
Lastly, I noted exports should pick up some, but I didn’t think enough to sustain growth.
I underestimated export strength, and while GDP hasn’t been stellar as before, it’s been a bit higher than i expected as exports boomed.
That was my first ‘major theme’ – slowing demand.
The second major theme was rising prices – Saudis acting the swing producer and setting price. This was interrupted when Goldman changed their commodity index in aug 06 triggering a massive liquidation as pension funds rebalanced, and oil prices fell from near 80 to about 50, pushed down a second time at year end by Goldman (and AIG as well this time) doing it again. As the liquidation subsided the Saudis were again in control and prices have marched up ever since, and with Putin gaining control of Russian pricing we now have to ‘price setters’ who can act a swing producers and simply set price at any level they want as long as net demand holds up. So far demand has been more than holding up, so it doesn’t seem we are anywhere near the limits of how high they can hike prices.
Saudi production for December should be out tomorrow. It indicates how much demand there is at current prices. If it’s up that means they have lots of room to hike prices further. Only if their production falls are they in danger of losing control on the downside. And I estimate it would have to fall below 7 million bpd for that to happen. It has been running closer to 9 million.
What I have missed is the fed’s response to all this.
I thought the inflation trend would keep them from cutting, as they had previously been strict adherents to the notion that price
stability is a necessary condition for optimal employment and growth.
This is how they fulfilled their ‘dual mandate’ of full employment and price stability, as dictated by ‘law’ and as per their regular reports to congress.
The theory is that if the fed acts to keep inflation low and stable markets will function to optimize employment and growth, and keep long term interest rates low.
What happened back in September is they became preoccupied with ‘market functioning’ which they see as a necessary condition for low inflation to be translated into optimal employment and growth.
What was revealed was the FOMC’s lack of understanding of not only market functioning outside of the fed, but a lack of understanding of their own monetary operations, reserve accounting, and the operation of their member bank interbank markets and pricing mechanisms.
In short, the Fed still isn’t fully aware that ‘it’s about price (interest rates), not quantity (‘money supply, whatever that may be)’.
(Note they are still limiting the size of the TAF operation using an auction methodology rather than simply setting a yield and letting quantity float)
The first clue to this knowledge shortfall was the 2003 change to put the discount rate higher than the fed funds rate, and make the discount rate a ‘penalty rate.’ This made no sense at all, as i wrote back then.
The discount rate is not and can not be a source of ‘market discipline’ and all the change did was create an ‘unstable equilibrium’ condition in the fed funds market. (They can’t keep the system ‘net borrowed’ as before) it all works fine during ‘normal’ periods but when the tree is shaken the NY Fed has it’s hands full keeping the funds rate on target, as we’ve seen for the last 6 months
or so.
While much of this FOMC wasn’t around in 2002-2003, several members were.
Back to September 2007. The FOMC was concerned enough about ‘market functioning’ to act, They saw credit spreads widening, and in particular the fed funds/libor spread was troubling as it indicated their own member banks were pricing each other’s risk at higher levels than the FOMC wanted. If they had a clear, working knowledge of monetary ops and reserve accounting, they would have recognized that either the discount window could be ‘opened’ by cutting the rate to the fed funds rate, removing the ‘stigma’ of using it, and expanding the eligible collateral. (Alternatively, the current TAF is functionally the same thing, and could have been implemented in September as well.)
Instead, they cut the fed funds rate 50 bp, and left the discount rate above it, along with the stigma. and this did little or nothing for the FF/LIBOR spread and for market functioning in general.
This was followed by two more 25 cuts and libor was still trading at 9% over year end until they finally came up with the TAF which immediately brought ff/libor down. It didn’t come all the way down to where the fed wanted it because the limited the size of the TAFs to $20 billion, again hard evidence of a shortfall in their understanding of monetary ops.
Simple textbook analysis shows it’s about price and not quantity. Charles Goodhart has over 65 volumes to read on this, and the first half of Basil Moore’s 1988 ‘Horizontalists and Verticalsists’ is a good review as well.
The ECB’s actions indicate they understand it. Their ‘TAF’ operation set the interest rate and let the banks do all they wanted, and over 500 billion euro cleared that day. And, of course- goes without saying- none of the ‘quantity needles’ moved at all.
In fact, some in the financial press have been noting that with all the ‘pumping in of liquidity’ around the world various monetary
aggregates have generally remained as before.
Rather than go into more detail about monetary ops, and why the CB’s have no effect on quantities, suffice to say for this post that the Fed still doesn’t get it, but maybe they are getting closer.
So back to the point.
Major themes are:
And more recently, the Fed cutting interest rates due to ‘market functioning’ in a mistaken notion that ff cuts would address that issue, followed by the TAF which did address the issue. The latest announced tafs are to be 30 billion, up from 20, but still short of the understanding that it’s about price, not quantity.
The last four months have also given the markets the impression that the Fed in actual fact cares not at all about inflation, and will only talk about it, but at the end of the day will act to support growth and employment.
Markets acknowledge that market functioning has been substantially improved, with risk repriced at wider spreads.
However, GDP prospects remain subdued, with a rising number of economists raising the odds of negative real growth.
While this has been the forecast for several quarters, and so far each quarter has seen substantial upward revisions from the initial forecasts, nonetheless the lower forecasts for Q1 have to be taken seriously, as that’s all we have.
I am in the dwindling camp that the Fed does care about inflation, and particularly the risk of inflation expectations elevating which would be considered the ultimate Central Bank blunder. All you hear from FOMC members is ‘yes, we let that happen in the 70’s, and we’re not going to let that happen again’.
And once ‘markets are functioning’ low inflation can again be translated via market forces into optimal employment and growth, thereby meeting the dual mandate.
i can’t even imagine a Fed chairman addressing congress with the reverse – ‘by keeping the economy at full employment market forces will keep inflation and long term interest rates low’.
Congress does not want inflation. Inflation will cost them their jobs. Voters hate inflation. They call it the govt robbing their
savings. Govt confiscation of their wealth. They start looking to the Ron Paul’s who advocate return to the gold standard.
That’s why low inflation is in the Fed’s mandate.
And the Fed also knows they are facing a triple negative supply shock of fuel, food, and import prices/weak $.
While they can’t control fuel prices, what they see there job as is keeping it all a relative value story and not ‘monetizing it into an
inflation story’ which means to them not accommodating it with low real rates that elevate inflation expectations, followed by
accelerating inflation.
There is no other way to see if based on their models. Deep down all their models are relative value models, with no source of the ‘price level.’ ‘Money’ is a numeraire that expresses the relative values. The current price level is there as a consequence of history, and will stay at that level only if ‘inflation expectations are well anchored.’ The ‘expectations operator’ is the only source of the price level in their models.
(See ‘Mandatory Readings‘ for how it all actually works.)
They also know that food/fuel prices are a leading cause of elevated inflation expectations.
In their world, this means that if demand is high enough to drive up CPI it’s simply too high and they need to not accommodate it with low real rates, but instead lean against that wind with higher real rates, or risk letting the inflation cat out of the bag and face a long, expensive, multi year battle to get it back in.
They knew this at the Sept 18 meeting when they cut 50, and twice after that with the following 25 cuts, all as ‘insurance to forestall’ the possible shutdown of ‘market functioning’.
And they knew and saw the price of this insurance – falling dollar, rising food, fuel, and import prices, and CPI soaring past 4% year over year.
To me these cuts in the face of the negative supply shocks define the level of fear, uncertainty, and panic of the FOMC.
It’s perhaps something like the fear felt by a new pilot accidentally flying into a thunderstorm in his first flight in an unfamiliar plane without an instructor or a manual.
The FOCM feared a total collapse of the financial structure. The possibility GDP going to 0 as the economy ‘froze.’ Better to do
something to buy some time, pay whatever inflation price that may follow, than do nothing.
The attitude has been there are two issues- recession due to market failure and inflation.
The response has been to address the ‘crisis’ first, then regroup and address the inflation issue.
And hopefully inflation expectations are well enough anchored to avoid disaster on the inflation front.
So now with the TAF’s ‘working’ (duh…) and market functions restored (even commercial paper is expanding again) the question is what they will do next.
They may decide markets are still too fragile to risk not cutting, as priced in by Feb fed funds futures, and risk a relapse into market dysfunction. Recent history suggests that’s what they would do if the Jan meeting were today.
But it isn’t today, and a lot of data will come out in the next few weeks. Both market functioning data and economic data.
Yes, the economy may weaken, and may go into recession, but with inflation on the rise, that’s the ‘non inflationary speed limit’ and the Fed would see cutting rates to support demand as accomplishing nothing for the real economy, but only increasing inflation and risking elevated inflation expectations. The see real growth as supply side constrained, and their job is keeping demand balanced at a non inflationary level.
But that assumes markets continue to function, and the supply side of credit doesn’t shut down and send GDP to zero in a financial panic.
With a good working knowledge of monetary ops and reserve accounting, and banking in general that fear would vanish, as the FOMC would know what indicators to watch and what buttons to push to safely fly the plane.
Without that knowledge another FF cut is a lot more likely.
more later…
warren
♥
Crisis may make 1929 look a ‘walk in the park’
Telegraph
by Ambrose Evans-PritchardAs central banks continue to splash their cash over the system, so far to little effect, Ambrose Evans-Pritchard argues that things risk spiralling out of their control
Twenty billion dollars here, $20bn there, and a lush half-trillion from the European Central Bank at give-away rates for Christmas.
Buckets of liquidity are being splashed over the North Atlantic banking system, so far with meagre or fleeting effects.
It’s about price, not quantity (net funds are not altered), and the CB actions have helped set ‘policy rates’ at desired levels.
That is all the CBs can do, apart from altering the absolute level of rates, which, by their own research, does little or nothing and with considerable lags.
Not to say changing rates isn’t disruptive as it shifts nominal income/wealth between borrowers and savers of all sorts.
As the credit paralysis stretches through its fifth month, a chorus of economists has begun to warn that the world’s central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.
“Liquidity doesn’t do anything in this situation,” says Anna Schwartz, the doyenne of US monetarism and life-time student (with Milton Friedman) of the Great Depression.
The last major, international fixed exchange rate/gold standard implosion. Other since – ERM, Mexico, Russia, Argentina – have been ‘contained’ to the fixed fx regions.
“It cannot deal with the underlying fear that lots of firms are going bankrupt. The banks and the hedge funds have not fully acknowledged who is in trouble. That is the critical issue,” she adds.
The critical issue at the macro policy level is what it is all doing to the aggregate demand that sustains output, employment, and growth. So far so good on that front, but it remains vulnerable, especially given the state of knowledge of macro economics and fiscal/monetary policy around the globe.
Lenders are hoarding the cash, shunning peers as if all were sub-prime lepers. Spreads on three-month Euribor and Libor – the interbank rates used to price contracts and Club Med mortgages – are stuck at 80 basis points even after the latest blitz. The monetary screw has tightened by default.
The CB can readily peg Fed Funds vs. LIBOR at any spread they wish to target.
York professor Peter Spencer, chief economist for the ITEM Club, says the global authorities have just weeks to get this right, or trigger disaster.
Seems they pretty much did before year end. Spreads are narrower now and presumably at CB targets.
“The central banks are rapidly losing control. By not cutting interest rates nearly far enough or fast enough, they are
allowing the money markets to dictate policy. We are long past worrying about moral hazard,” he says.
They have allowed ‘markets’ to dictate as the entire FOMC and others have revealed a troubling lack of monetary operations and reserve accounting.
“They still have another couple of months before this starts imploding. Things are very unstable and can move incredibly fast. I don’t think the central banks are going to make a major policy error, but if they do, this could make 1929 look like a walk in the park,” he adds.
Hard to do with floating exchange rates, but not impossible if they try hard enough!
The Bank of England knows the risk. Markets director Paul Tucker says the crisis has moved beyond the collapse of mortgage securities, and is now eating into the bedrock of banking capital. “We must try to avoid the vicious circle in which tighter liquidity conditions, lower asset values, impaired capital resources, reduced credit supply, and slower aggregate demand feed back on each other,” he says.
Seems a lack of understanding of the ‘suppy side’ of money/credit is pervasive and gives rise to all kinds of ‘uncertainties’ (AKA – fears, as in being scared to an extreme).
New York’s Federal Reserve chief Tim Geithner echoed the words, warning of an “adverse self-reinforcing dynamic”, banker-speak for a downward spiral. The Fed has broken decades of practice by inviting all US depositary banks to its lending window, bringing dodgy mortgage securities as collateral.
Banks can only own what the government puts on their ‘legal list’, and banks can issue government insured deposits, which is government funding, in order to fund government approved assets.
Functionally, there is no difference between issuing government insured deposits to fund their legal assets and using the discount window to do the same. The only difference may be the price of the funds, and the fed controls that as a matter of policy.
Quietly, insiders are perusing an obscure paper by Fed staffers David Small and Jim Clouse. It explores what can be done under the Federal Reserve Act when all else fails.
Section 13 (3) allows the Fed to take emergency action when banks become “unwilling or very reluctant to provide credit”. A vote by five governors can – in “exigent circumstances” – authorise the bank to lend money to anybody, and take upon itself the credit risk. This clause has not been evoked since the Slump.
The government already does this. They already determine legal bank assets, capital requirements, and via various government agencies and association advance government guaranteed loans of all types.
This is business as usual – all presumably for public purpose.
Get over it!!!
Yet still the central banks shrink from seriously grasping the rate-cut nettle. Understandably so. They are caught between the Scylla of the debt crunch and the Charybdis of inflation. It is not yet certain which is the more powerful force.
Yes, as they cling to the belief that ‘inflation’ is a ‘strong’ function of interest rates, while it is an oil monopolist or two and a government induced and supported link from crude to food via biofuels that are driving up CPI and inflation in general.
America’s headline CPI screamed to 4.3 per cent in November. This may be a rogue figure, the tail effects of an oil, commodity, and food price spike. If so, the Fed missed its chance months ago to prepare the markets for such a case. It is now stymied.
CPI might also be headed higher if crude continues its advance.
This has eerie echoes of Japan in late-1990, when inflation rose to 4 per cent on a mini price-surge across Asia. As the Bank of Japan fretted about an inflation scare, the country’s financial system tipped into the abyss.
As I recall, it was a tax hike that hurt GDP.
Yes, the world economies are vulnerable to a drop in GDP growth, but the financial press seems to have the reasoning totally confused.
♥
Higher oil prices mean lower rates from the Fed, and higher inflation rates induced by shortages mean stronger currencies abroad.
Why do I have so much trouble getting aboard this paradigm, and instead keep looking for reversals? Feels a lot like watching the NASDAQ go from 3500 to 5000 a few years ago.
:(
Calories, Capital, Climate Spur Asian Anxiety
2007-12-26 17:51 (New York)
by Andy Mukherjee
(Bloomberg) — The new year may be a challenging one for Asian policy makers.
Year-end U.S. closing stocks for wheat are the lowest in six decades; soybeans in Chicago touched a 34-year peak this week. Palm oil in Malaysia climbed to a record yesterday.
The steeply rising cost of calories may be more than just cyclical, notes Rob Subbaraman, Lehman Brothers Holdings Inc. economist in Hong Kong. Growing use of food crops in biofuels and increasing demand for a protein-rich diet in developing countries may have pushed up prices more permanently.
The wholesale price of pork in China has surged 53 percent in the past year.
“Consumer inflationary expectations may soon rise, feeding into wage growth and core inflation, but we expect Asian central banks to be slow to react, initially due to slowing growth and later because of strong capital inflows,” Subbaraman says.
If the U.S. Federal Reserve continues easing interest rates to combat a housing-led economic slowdown, a surge in capital inflows into Asia may indeed become a stumbling block in managing the inflationary impact of higher commodity prices.
Food and energy account for more than two-fifths of the Chinese consumer-price index, compared with 17 percent for countries such as the U.K., U.S. and Canada, and 25 percent in the euro area, according to UBS AG economist Paul Donovan in London.
As Asian central banks raise interest rates — when the Fed is cutting them — they will invite even more foreign capital into the region. That will cause Asian currencies to appreciate, leading to a loss of competitiveness for the region’s exports.
Carbon Emissions
On the other hand, paring the domestic cost of money prematurely may worsen the inflation challenge.
That isn’t all.
Higher oil prices will also boost the attractiveness of coal as an energy source, delaying any meaningful reduction in carbon emissions in fast-growing Asian nations such as China and India.
As Daniel Gros, director of the Centre for European Policy Studies in Brussels, noted in recent research, the price of coal — relative to crude oil — has been halved since the end of 1999. And per unit of energy produced, coal is a much bigger pollutant than oil or gas.
This doesn’t augur well for the environment.
“Given that China is likely to install over the next decade more new power generation capacity than already exists in all of Europe, this implies that the current level of high oil prices provides incentive to make the Chinese economy even more intensive in carbon than it would otherwise be,” Gros said.
Beijing Olympics
Climate-related issues will be in the spotlight in Asia next year. China’s eagerness to use the Beijing Olympic Games to showcase solutions to its huge environmental challenges will be one of the “big things to watch for” in Asia in 2008, Spire Research and Consulting, a Singapore-based advisory firm, said last week.
Even if China succeeds in reducing air pollution during the Olympics, the improvements may not endure after the sporting event ends on Aug. 24, especially since the underlying economics continue to favor higher coal usage.
A drop in hydrocarbon prices might help check emissions and global warming, Gros noted last week on the Web site of VoxEu.org.
In fact, lower oil prices may also make food costs more stable by lessening the craze for biofuels.
That will leave capital flows as Asia’s No. 1 challenge in 2008. And it won’t be an easy one for policy makers to tackle.
Capital Inflows
Take India’s example.
The $900 billion economy has attracted $100 billion in capital in the 12 months through October, with a third of the money entering the country as overseas borrowings, according to Morgan Stanley economist Chetan Ahya in Singapore.
This has caused the rupee to appreciate more than 12 percent against the dollar this year, knocking off more than three percentage points from India’s inflation index, says Lombard Street Research economist Maya Bhandari in London.
Naturally, exporters are complaining.
So why doesn’t India cut domestic interest rates? It can’t do that without the risk of stoking inflation.
Money supply is growing at an annual pace of more than 21 percent in India, compared with the central bank’s target of between 17 percent and 17.5 percent. Inflation has held well below the central bank’s estimate of 5 percent for five straight months partly because of the government’s insistence on not passing the full cost of imported fuel to local consumers. It isn’t yet time for monetary easing in India.
China has it worse. Monetary conditions there remain dangerously loose. And China may be reluctant to do much about the undervalued yuan — the root cause of its record trade surpluses and the attendant liquidity glut — until the Olympics are out of the way.
Asian economies may, to a large extent, be insulated from the subprime mess. Still, 2008 won’t be all fun and games.
(Andy Mukherjee is a Bloomberg News columnist. The opinions expressed are his own.)
–Editors: James Greiff, Ron Rhodes.
To contact the writer of this column:
Andy Mukherjee in Singapore at +65-6212-1591 or
amukherjee@bloomberg.net
To contact the editor responsible for this column:
James Greiff at +1-212-617-5801 or jgreiff@bloomberg.net
♥
Falling deficits in general in the Eurozone due to the growth rate of GDP combined and the countercyclical tax structure.
Aggregate demand from non government credit expansion (and some from exports) is supporting GDP as support from government deficit spending wanes. This can go on for quite a while as consumer leverage still has a lot of upside potential. However, it will self-destruct if allowed to continue long enough. And, as in the US, net exports have the potential to sustain growth in the medium term as well, though this is hard to fathom without a fall in the Euro.
I need to do more work on this as there are a lot of moving parts over there, including prospective members targeting their currencies, building Euro reserves (public and private), and tightening their fiscal balances. Additionally, portfolios have been rebalancing toward the Euro.
Overall, however, we enter 2008 with tightening fiscal balances in most countries. This will serve to keep a lid on demand and output, while rising food/energy will keep upward pressure on prices.
Italy’s 2007 public deficit about 2 pct of GDP
Prodi 27 Dec 2007 06:39 AM ET
Thomson Financial
Italy’s public deficit will be about 2 pct of GDP, compared with a government forecast of 2.5 pct, said prime minister Romano Prodi in his year-end address.
“We will close the year with a lower deficit, it will be around 2 pct, a figure below any forecast,” Prodi said.
philip.webster@thomson.com pw/ejb COPYRIGHT Copyright Thomson
Financial News Limited 2007. All rights reserved.
♥
Give Saudi/Russians comfort that they can keep hiking.
And markets say Fed will keep ‘accommodating’.
So much for higher prices curbing demand!
DJ US Gasoline Demand +0.9% On Week – MasterCard SpendingPulse(DJ)
NEW YORK (Dow Jones)–U.S. gasoline demand for the week ended Dec. 21, measured by purchases at the pump, rose 0.9% from a week earlier, according to a report by MasterCard Advisors LLC, a division of MasterCard Inc. (MA). Gasoline demand increased by 597,000 barrels, or 85,286 barrels a day, to 67.919 million barrels, or 9.703 million barrels a day, last week, according to the report, which is compiled by SpendingPulse, a retail data service of MasterCard Advisors. The four-week average demand level was 65.518 million barrels, or 9.36 million barrels a day, MasterCard said, up from 96,429 barrels a day from a week ago. Retail gasoline prices fell 1 cent to an average $2.98 a gallon over the week, the report said. That is 28.4% higher than a year ago.
SpendingPulse is a macroeconomic indicator that reports on national retail sales and is based on aggregate sales activity in the MasterCard payments network, coupled with estimates for all other payment forms, including cash and check. MasterCard SpendingPulse doesn’t represent MasterCard financial performance. The Department of Energy is due to issue its weekly petroleum data, including gasoline demand, on Thursday at 10:30 a.m. EST.
The data, put out by the DOE’s Energy Information Administration statistics and analysis unit, doesn’t count how many gallons are sold. Instead, it offers a “Product Supplied,” or implied demand figure, in its weekly report. “Product Supplied” represents the total volume of gasoline that has moved on from refineries, pipelines, blending plants and terminals on its way to supplying retail stations.
-By Matt Chambers, Dow Jones Newswires; 201-938-2062;
matt.chambers@dowjones.com
Dow Jones Newswires
December 26, 2007 14:00 ET (19:00 GMT)
Copyright (c) 2007 Dow Jones & Company, Inc. – – 02 00 PM EST
♥
Looks like markets are still trading with the assumption that as the Saudis/Russians hike prices the Fed will accommodate with rate cut.
That’s a pretty good incentive for more Saudi/Russian oil price hikes, as if they needed any!
Likewise, the US is a large exporter of grains and foods.
Those prices are now linked to crude via biofuels.
And the new US energy bill just passed with about $36 billion in subsidies for biofuels to help us keep burning up our food for fuel and keeping their prices linked.
This means cpi will continue to trend higher, and drag core up with it as costs get passed through via a variety of channels. In the early 70’s core didn’t go through 3% until cpi went through 6%, for example.
Ultimately everything is made of food and energy, and margins don’t contract forever with softer demand. In fact, much of the private sector is straight cost plus pricing, and govt is insensitive to ‘demand’ and insensitive to the prices of what it buys. And the US govt. indexes compensation and most transfer payments to (headline) cpi.
And while the US may be able to pay it’s rising oil bill with help from its rising export prices for food, much of the rest of the world is on the wrong end of both and will see its real terms of trade continue to deteriorate. Not to mention the likelihood of increased outright starvation as ultra low income people lose their ability to buy enough calories to stay alive as they compete with the more affluent filling up their tanks.
At the Jan 30 meeting I expect the Fed to be looking at accelerating inflation due to rising food/crude, and an economy muddling through with a q4 gdp forecast of 2-3%. Markets will be functioning, banks getting recapitalized, and while there has been a touch of spillover from Wall st. to Main st. the risk of a sudden, catastrophic collapse has to appear greatly diminished.
They have probably learned that the fed funds cuts did little or nothing for ‘market functioning’ and that the TAF brought ff/libor under control by accepting an expanded collateral list from its member banks.
(In fact, the TAF is functionally equiv of expanding the collateral accepted at the discount window, cutting the rate, and removing the stigma as recommended back in August and several times since.)
And they have to know their all important inflation expectations are at the verge of elevating.
They will know demand is strong enough to be driving up cpi, and the discussion will be the appropriate level of demand and the fed funds rate most likely to sustain non inflationary growth.
Their ‘forward looking’ models probably will still use futures prices, and with the contangos in the grains and energy markets, the forecasts will be for moderating prices. But by Jan 30 they will have seen a full 6 months of such forecasts turn out to be incorrect, and 6 months of futures prices not being reliable indicators of future inflation.
Feb ff futures are currently pricing in another 25 cut, indicating market consensus is the Fed still doesn’t care about inflation. Might be the case!
♥
CNBC just had a session on trying to reconcile high gdp with large credit losses. Seems they are now seeing the consumer clipping along at a +2.8% pace for Q4. No need to rehash my ongoing position that most if not all the losses announced in the last 6 months would have little or no effect on aggregate demand. Credit losses hurt demand when the result is a drop in spending. And yes, that happened big time when the subprime crisis took the bid away from would be subprime buyers who no longer qualified to buy a house. That probably took 1% away from gdp, and the subsequent increase in
exports kept gdp pretty much where it was. But that story has been behind us for over a year.
The Fed is not in a good place. They should now know that the TAF operation should have been done in August to keep libor priced where they wanted it. They should know by now losses per se don’t alter aggregate demand, but only rearrange financial assets. The should know the fall off in subprime buyers was offset by exports.
The problem was the FOMC- as demonstrated by their speeches and actions- did not have an adequate working understanding of monetary operations and reserve accounting back in August, and by limiting the current TAFs to $20 billion it seems they still don’t even understand that it’s about price, and not quantity. Too many members of the FOMC
are mostly likely in a fixed exchange rate paradigm, with its fix exchange rate/gold standard fractional reserve banking system that drove us into the great depression. With fixed exchange rates it’s a ‘loanable funds’ world. Banks are ‘reserve constrained.’ Reserves and consequently ‘money supply’ are issues. Government solvency is an issue.
With today’s floating exchange rate regime none of that is applicable. The causation is ‘loans create deposits AND reserves,’ and bank capital is endogenous. There are no ‘imbalances’ as all current conditions are ‘priced’ in the fx market, including ANY sized trade gap, budget deficit, or rate of inflation.
The recession risk today is from a lack of effective demand. There are lots of ways this can happen- sudden drop in govt spending, sudden tax increase, consumers change ‘savings desires’ and cut back spending, sudden drop in exports, etc.- and in any case the govt can instantly fill in the gap with net spending to sustain demand at any level it desires. Yes, there will be inflation consequences, distribution consequences, but no govt. solvency consequences.
So yes, there is always the possibility of a recession. And domestic demand (without exports) has been moderating as the falling govt budget acts to reduce aggregate demand. But the rearranging of financial assets in this ‘great repricing of risk’ doesn’t necessarily reduce aggregate demand.
Meanwhile, the Saudis, as swing producer, keep raising the price of crude, and so far with no fall off in the demand for their crude at current prices, so they are incented to keep right on hiking. And they may even recognize that by spending their new found revenues on real goods and services (note the new mid east infrastructure projects in progress) they keep the world economy afloat and can keep hiking prices indefinitely.
And food is linked to fuel via biofuels, and as we continue to burn up every larger chunks of our food supply for fuel prices will keep rising.
The $US is probably stable to firm at current levels vs the non commodity currencies, as portfolio shifts have run their course, and these shifts have driven the $ down to levels where there are ‘real buyers’ as evidenced by rapidly growing exports.
Back to the Fed – they have cut 100 bp into the triple negative supply shock of food, crude, and the $/imported prices, due to blind fear of ‘market functioning’ that turned out to need nothing more than an open market operation with expanded acceptable bank collateral (the TAF program). If they had done that immediately (they had more than one outsider and insider recommend it) and fed funds/libor spreads and other ‘financial conditions’ moderated, would they have cut?
There has been no sign of ‘spillover’ into gdp from the great repricing of risk, food and crude have driven their various inflation measures to very uncomfortable levels,and they now believe they have ‘cooked in’ 100 bp of inflationary easing into the economy that works with about a one year lag.
Merry Christmas!
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(an email and an article)
On Dec 23, 2007 5:37 PM, Russell Huntley wrote:
>
>
>
> For a very bearish take on the credit crisis, see: Crisis may make 1929 look
> a ‘walk in the park’. The article includes a $700 billion loss estimate from
> the head of credit at Barclays capital:
>
> Goldman Sachs caused shock last month when it predicted that total crunch
> losses would reach $500bn,
Yes, could be. Rearranging of financial assets.
leading to a $2 trillion contraction in lending
> as bank multiples kick into reverse.
I don’t see this as a consequence. Bank lending will go in reverse only if there are no profitable loans to be made.
With floating exchange rates, bank capital in endogenous and will respond to returns on equity.
This already seems humdrum.
>
> “Our counterparties are telling us that losses may reach $700bn,” says Rob
> McAdie, head of credit at Barclays Capital. Where will it end? The big banks
> face a further $200bn of defaults in commercial property. On it goes.
Been less than 100 billion so far. Maybe they are talking cumulatively over the next five years?
>
> UPDATE: My main interest in this article was the quote from Barclays
> Capital. There has been a growing agreement that the mortgage credit crisis
> would result in losses of perhaps $400B to $500B; this is the first estimate
> I’ve seen significantly above that number.
>
> I noted last week that a $1+ trillion mortgage loss number is possible if it
> becomes socially acceptable for the middle class to walk away from their
> upside down mortgages.
Historically, people just don’t walk out onto the streets. They are personally liable for the payments regardless of current equity positions, and incomes are still strong, nationally broader surveys show home prices still up a tad ear over year.
Yes, some condo flippers and speculators will walk. But demand from that source has already gone to zero – did so over a yar ago, so that doesn’t alter aggregate demand from this point.
And that doesn’t include losses in CRE, corporate
> debt and the decrease in household net worth.
Different things, but again, the key to GDP is whether demand will hold up, including exports.
And probably half of aggregate demand comes directly or indirectly from the government. Don’t see that going negative. And AMT tax just cut fifty billion for 2008 will help demand marginally.
>
> The S&L crisis was $160B, so even adjusting for inflation, the current
> crisis is much worse than the S&L crisis (see page 13 of this GAO document).
That was net government losses? Shareholders/investors lost a lot more?
And a $1 trillion per day move in the world equity values happens all the time.
Q4 GPD being revised up to the 2% range. This has happened every quarter for quite a while.
Yes, it can all fall apart, but it hasn’t happened yet. And while there are risks to demand, negative GDP is far from obvious. Those predicting recessions mainly use yield curve correlations with past cycles and things like that.
Interesting that the one thing that is ‘real’ and currently happening is ‘inflation’, which the fed doesn’t seem to care about. And it won’t stop until crude stops climbing.
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Agree, if food/crude/import&export prices keep rising, there will be serious fireworks between congress and the fed. This will include blaming the fed for the high gasoline prices, for example.
Greenspan sees early signs of U.S. stagflation
U.S. economy is showing early signs of stagflation as growth threatens to stall while food and energy prices soar, former U.S. Federal Reserve Chairman Alan Greenspan said on Sunday.
In an interview on ABC’s “This Week with George Stephanopoulos,” Greenspan said low inflation was a major contributor to economic growth and prices must be held in check.
“We are beginning to get not stagflation, but the early symptoms of it,” Greenspan said.
“Fundamentally, inflation must be suppressed,” he added. “It’s critically important that the Federal Reserve is allowed politically to do what it has to do to suppress the inflation rates that I see emerging, not immediately, but clearly over the intermediate and longer-term period.”
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