The Center of the Universe

The BoEs sharp shock to monetary illusions

The Old Lady (of Threadneedle Street) fails to get an A

When asked about the growth in hourly wages:

Most measures of wage increases are running at very low levels. Wage inflation closer to 3% or 4% would be expected given some measures, such as productivity growth. But right now it is certainly not flashing. An increase in it might signal some tightening or meaningful increase over time. I would say were not seeing that.

It’s well publicized that real wages have been lagging for maybe 40 years, as profits hit an all time high of about 11% of GDP. So as a point of logic the only way wages can stop the slide is if they grow faster than GDP grows, which leads to the ‘where the productivity growth has been going’ discussion, etc. Furthermore, in today’s economy the distribution is largely and necessarily a result of an impossibly ‘complex’, global, institutional structure rather than ‘free market forces’.

Add to that the Fed only has ‘one lever’ which is interest rates, and they all believe that lowering rates is ‘easing’, and that GDP growth promotes wage grow. So it could be that hourly wage growth of 2% that looks like it’s heading to prior highs of around 4% per se might not be all that strong a factor for quite a while in their reaction function?

Lessons from Crises, 1985-2014

Stanley Fischer[1]


It is both an honor and a pleasure to receive this years SIEPR Prize. Let me list the reasons. First, the prize, awarded for lifetime contributions to economic policy, was started by George Shultz. I got my start in serious policy work in 1984-85, as a member of the advisory group on the Israeli economy to George Shultz, then Secretary of State. I learned a great deal from that experience, particularly from Secretary Shultz and from Herb Stein, the senior member of the two-person advisory group (I was the other member). Second, it is an honor to have been selected for this prize by a selection committee consisting of George Shultz, Ken Arrow, Gary Becker, Jim Poterba and John Shoven. Third, it is an honor to receive this prize after the first two prizes, for 2010 and for 2012 respectively, were awarded to Paul Volcker and Marty Feldstein. And fourth, it is a pleasure to receive the award itself.

When John Shoven first spoke to me about the prize, he must have expected that I would speak on the economic issues of the day and I would have been delighted to oblige. However, since then I have been nominated by President Obama but not so far confirmed by the Senate for the position of Vice-Chair of the Federal Reserve Board. Accordingly I shall not speak on current events, but rather on lessons from economic crises I have seen up close during the last three decades and about which I have written in the past starting with the Israeli stabilization of 1985, continuing with the financial crises of the 1990s, during which I was the number two at the IMF, and culminating (I hope) in the Great Recession, which I observed and with which I had to deal as Governor of the Bank of Israel between 2005 and 2013.

This is scheduled to be an after-dinner speech at the end of a fine dinner and after an intensive conference that started at 8 a.m. and ran through 6 p.m. Under the circumstances I shall try to be brief. I shall start with a list of ten lessons from the last twenty years, including the crises of Mexico in 1994-95, Asia in 1997-98, Russia in 1998, Brazil in 1999-2000, Argentina in 2000-2001, and the Great Recession. I will conclude with one or two-sentence pieces of advice I have received over the years from people with whom I had the honor of working on economic policy. The last piece of advice is contained in a story from 1985, from a conversation with George Shultz.


I. Ten lessons from the last two decades.[2]


Lesson 1: Fiscal policy also matters macroeconomically. It has always been accepted that fiscal policy, in the sense of the structure of the tax system and the composition of government spending, matters for the behavior of the economy. At times in the past there has been less agreement about whether the macroeconomic aspects of fiscal policy, frequently summarized by the full employment budget deficit, have a significant impact on the level of GDP. As a result of the experience of the last two decades, it is once again accepted that cutting government spending and raising taxes in a recession to reduce the budget deficit is generally recessionary. This was clear from experience in Asia in the 1990s.[3] The same conclusion has been reached following the Great Recession.

Who would have thought?…

At the same time, it needs to be emphasized that there are circumstances in which a fiscal contraction can be expansionary particularly for a country running an unsustainable budget deficit.

Unsustainable?
He doesn’t distinguish between floating and fixed fx policy. At best this applies to fixed fx policy, where fx reserves would be exhausted supporting the peg/conversion. And as a point of logic, with floating fx this can only mean an unsustainable inflation, whatever that means.

More important, small budget deficits and smaller rather than larger national debts are preferable in normal times in part to ensure that it will be possible to run an expansionary fiscal policy should that be needed in a recession.

Again, this applies only to fixed fx regimes where a nation might need fx reserves to support conversion at the peg. With floating fx nominal spending is in no case revenue constrained.

Lesson 2: Reaching the zero interest lower bound is not the end of expansionary monetary policy. The macroeconomics I learned a long time ago, and even the macroeconomics taught in the textbooks of the 1980s and early 1990s, proclaimed that more expansionary monetary policy becomes either impossible or ineffective when the central bank interest rate reaches zero, and the economy finds itself in a liquidity trap. In that situation, it was said, fiscal policy is the only available expansionary tool of macroeconomic policy.

Now the textbooks should say that even with a zero central bank interest rate, there are at least two other available monetary policy tools. The first consists of quantitative easing operations up and down the yield curve, in particular central bank market purchases of longer term assets, with the intention of reducing the longer term interest rates that are more relevant than the shortest term interest rate to investment decisions.

Both are about altering the term structure of rates. How about the lesson that the data seems to indicate the interest income channels matter to the point where the effect is the reverse of what the mainstream believes?

That is, with the govt a net payer of interest, lower rates lower the deficit, reducing income and net financial assets credited to the economy. For example, QE resulted in some $90 billion of annual Fed profits returned to the tsy that otherwise would have been credited to the economy. That, with a positive yield curve, QE functions first as a tax.

The second consists of central bank interventions in particular markets whose operation has become significantly impaired by the crisis. Here one thinks for instance of the Feds intervening in the commercial paper market early in the crisis, through its Commercial Paper Funding Facility, to restore the functioning of that market, an important source of finance to the business sector. In these operations, the central bank operates as market maker of last resort when the operation of a particular market is severely impaired.

The most questionable and subsequently overlooked ‘bailout’- the Fed buying, for example, GE commercial paper when it couldn’t fund itself otherwise, with no ‘terms and conditions’ as were applied to select liquidity provisioning to member banks, AIG, etc. And perhaps worse, it was the failure of the Fed to provide liquidity (not equity, which is another story/lesson) to its banking system on a timely basis (it took months to get it right) that was the immediate cause of the related liquidity issues.

However, and perhaps the most bizarre of what’s called unconventional monetary policy, the Fed did provide unlimited $US liquidity to foreign banking systems with its ‘swap lines’ where were, functionally, unsecured loans to foreign central banks for the further purpose of bringing down Libor settings by lowering the marginal cost of funds to foreign banks that otherwise paid higher rates.

Lesson 3: The critical importance of having a strong and robust financial system. This is a lesson that we all thought we understood especially since the financial crises of the 1990s but whose central importance has been driven home, closer to home, by the Great Recession. The Great Recession was far worse in many of the advanced countries than it was in the leading emerging market countries. This was not what happened in the crises of the 1990s, and it was not a situation that I thought would ever happen. Reinhart and Rogoff in their important book, This Time is Different,[4] document the fact that recessions accompanied by a financial crisis tend to be deeper and longer than those in which the financial system remains operative. The reason is simple: the mechanisms that typically end a recession, among them monetary and fiscal policies, are less effective if households and corporations cannot obtain financing on terms appropriate to the state of the economy.

The lesson should have been that the private sector is necessarily pro cyclical, and that a collapse in aggregate demand that reduces the collateral value of bank assets and reduces the income required to support the credit structure triggers a downward spiral that can only be reversed with counter cyclical fiscal policy.

In the last few years, a great deal of work and effort has been devoted to understanding what went wrong and what needs to be done to maintain a strong and robust financial system. Some of the answers are to be found in the recommendations made by the Basel Committee on Bank Supervision and the Financial Stability Board (FSB). In particular, the recommendations relate to tougher and higher capital requirements for banks, a binding liquidity ratio, the use of countercyclical capital buffers, better risk management, more appropriate remuneration schemes, more effective corporate governance, and improved and usable resolution mechanisms of which more shortly. They also include recommendations for dealing with the clearing of derivative transactions, and with the shadow banking system. In the United States, many of these recommendations are included or enabled in the Dodd-Frank Act, and progress has been made on many of them.

Everything except the recognition of the need for immediate and aggressive counter cyclical fiscal policy, assuming you don’t want to wait for the automatic fiscal stabilizers to eventually turn things around.

Instead, what they’ve done with all of the above is mute the credit expansion mechanism, but without muting the ‘demand leakages’/'savings desires’ that cause income to go unspent, and output to go unsold, leaving, for all practical purposes (the export channel isn’t a practical option for the heaving lifting), only increased deficit spending to sustain high levels of output and employment.

Lesson 4: The strategy of going fast on bank restructuring and corporate debt restructuring is much better than regulatory forbearance. Some governments faced with the problem of failed financial institutions in a recession appear to believe that regulatory forbearance giving institutions time to try to restore solvency by rebuilding capital will heal their ills. Because recovery of the economy depends on having a healthy financial system, and recovery of the financial system depends on having a healthy economy, this strategy rarely works.

The ‘problem’ is bank lending to offset the demand leakages when the will to use fiscal policy isn’t there.

And today, it’s hard to make the case that us lending is being constrained by lack of bank capital, with the better case being a lack of credit worthy, qualifying borrowers, and regulatory restrictions- called ‘regulatory overreach’ on some types of lending as well. But again, this largely comes back to the understanding that the private sector is necessarily pro cyclical, with the lesson being an immediate and aggressive tax cut and/or spending increase is the way go.

This lesson was evident during the emerging market crises of the 1990s. The lesson was reinforced during the Great Recession, by the contrast between the response of the U.S. economy and that of the Eurozone economy to the low interest rate policies each implemented. One important reason that the U.S. economy recovered more rapidly than the Eurozone is that the U.S. moved very quickly, using stress tests for diagnosis and the TARP for financing, to restore bank capital levels, whereas banks in the Eurozone are still awaiting the rigorous examination of the value of their assets that needs to be the first step on the road to restoring the health of the banking system.

The lesson remaining unlearned is that with a weaker banking structure the euro zone can implement larger fiscal adjustments- larger tax cuts and/or larger increases in public goods and services.

Lesson 5: It is critical to develop now the tools needed to deal with potential future crises without injecting public funds.

Yes, it seems the value of immediate and aggressive fiscal adjustments remains unlearned.

This problem arose during both the crises of the 1990s and the Great Recession but in different forms. In the international financial crises of the 1990s, as the size of IMF packages grew, the pressure to bail in private sector lenders to countries in trouble mounted both because that would reduce the need for official financing, and because of moral hazard issues. In the 1980s and to a somewhat lesser extent in the 1990s, the bulk of international lending was by the large globally active banks. My successor as First Deputy Managing Director of the IMF, Anne Krueger, who took office in 2001, mounted a major effort to persuade the IMF that is to say, the governments of member countries of the IMF to develop and implement an SDRM (Sovereign Debt Restructuring Mechanism). The SDRM would have set out conditions under which a government could legally restructure its foreign debts, without the restructuring being regarded as a default.

The lesson is that foreign currency debt is to be avoided, and that legal recourse in the case of default should be limited.

Recent efforts to end too big to fail in the aftermath of the Great Recession are driven by similar concerns by the view that we should never again be in a situation in which the public sector has to inject public money into failing financial institutions in order to mitigate a financial crisis. In most cases in which banks have failed, shareholders lost their claims on the banks, but bond holders frequently did not. Based in part on aspects of the Dodd-Frank Act, real progress has been made in putting in place measures to deal with the too big to fail problem. Among them are: the significant increase in capital requirements, especially for SIFIs (Systemically Important Financial Institutions) and the introduction of counter-cyclical capital buffers for banks; the requirement that banks hold a cushion of bail-in-able bonds; and the sophisticated use of stress tests.

The lesson is that the entire capital structure should be explicitly at full risk and priced accordingly.

Just one more observation: whenever the IMF finds something good to say about a countrys economy, it balances the praise with the warning Complacency must be avoided. That is always true about economic policy and about life. In the case of financial sector reforms, there are two main concerns that the statement about significant progress raises: first, in designing a system to deal with crises, one can never know for sure how well the system will work when a crisis situation occurs which means that we will have to keep on subjecting the financial system to tough stress tests and to frequent re-examination of its resiliency; and second, there is the problem of generals who prepare for the last war the financial system and the economy keep evolving, and we need always to be asking ourselves not only about whether we could have done better last time, but whether we will do better next time and one thing is for sure, next time will be different.

And in any case an immediate and aggressive fiscal adjustment can always sustain output and employment. There is no public purpose in letting a financial crisis spill over to the real economy.

Lesson 6: The need for macroprudential supervision. Supervisors in different countries are well aware of the need for macroprudential supervision, where the term involves two elements: first, that the supervision relates to the financial system as a whole, and not just to the soundness of each individual institution; and second, that it involves systemic interactions. The Lehman failure touched off a massive global financial crisis, a reflection of the interconnectedness of the financial system, and a classic example of systemic interactions. Thus we are talking about regulation at a very broad level, and also the need for cooperation among regulators of different aspects of the financial system.

The lesson are that whoever insures the deposits should do the regulation, and that independent fiscal adjustments can be immediately and aggressively employed to sustain output and employment in any economy.

In practice, macroprudential policy has come to mean the deployment of non-monetary and non-traditional instruments of policy to deal with potential problems in financial institutions or a part of the financial system. For instance, in Israel, as in other countries whose financial system survived the Great Recession without serious damage, the low interest rate environment led to uncomfortably rapid rates of increase of housing prices. Rather than raise the interest rate, which would have affected the broader economy, the Bank of Israel in which bank supervision is located undertook measures whose effect was to make mortgages more expensive. These measures are called macroprudential, although their effect is mainly on the housing sector, and not directly on interactions within the financial system. But they nonetheless deserve being called macroprudential, because the real estate sector is often the source of financial crises, and deploying these measures should reduce the probability of a real estate bubble and its subsequent bursting, which would likely have macroeconomic effects.

And real effects- there would have been more houses built. The political decision is the desire for real housing construction.

The need for surveillance of the financial system as a whole has in some countries led to the establishment of a coordinating committee of regulators. In the United States, that group is the FSOC (Financial Stability Oversight Council), which is chaired by the Secretary of the Treasury. In the United Kingdom, a Financial Policy Committee, charged with the responsibility for oversight of the financial system, has been set up and placed in the Bank of England. It operates under the chairmanship of the Governor of the Bank of England, with a structure similar but not identical to the Bank of Englands Monetary Policy Committee.

Lesson 7: The best time to deal with moral hazard is in designing the system, not in the midst of a crisis.

Agreed!
Moral hazard is about the future course of events.

At the start of the Korean crisis at the end of 1997, critics including friends of mine told the IMF that it would be a mistake to enter a program with Korea, since this would increase moral hazard. I was not convinced by their argument, which at its simplest could be expressed as You should force Korea into a greater economic crisis than is necessary, in order to teach them a lesson. The issue is Who is them? It was probably not the 46 million people living in South Korea at the time. It probably was the policy-makers in Korea, and it certainly was the bankers and others who had invested in South Korea. The calculus of adding to the woes of a country already going through a traumatic experience, in order to teach policymakers, bankers and investors a lesson, did not convince the IMF, rightly so to my mind.

Agreed!
Nor did they need an IMF program!

But the question then arises: Can you ever deal with moral hazard? The answer is yes, by building a system that will as far as possible enable policymakers to deal with crises in a way that does not create moral hazard in future crisis situations. That is the goal of financial sector reforms now underway to create mechanisms and institutions that will put an end to too big to fail.

There was no too big to fail moral hazard issue. The US banks did fail when shareholders lost their capital. Failure means the owners lose and are financially punished, and new owners with new capital have a go at it.

Lesson 8: Dont overestimate the benefits of waiting for the situation to clarify.


Early in my term as Governor of the Bank of Israel, when the interest rate decision was made by the Governor alone, I faced a very difficult decision on the interest rate. I told the advisory group with whom I was sitting that my decision was to keep the interest rate unchanged and wait for the next monthly decision, when the situation would have clarified. The then Deputy Governor, Dr. Meir Sokoler, commented: It is never clear next time; it is just unclear in a different way. I cannot help but think of this as the Tolstoy rule, from the first sentence of Anna Karenina, every unhappy family is unhappy in its own way.

It is not literally true that all interest rate decisions are equally difficult, but it is true that we tend to underestimate the lags in receiving information and the lags with which policy decisions affect the economy. Those lags led me to try to make decisions as early as possible, even if that meant that there was more uncertainty about the correctness of the decision than would have been appropriate had the lags been absent.

The lesson is to be aggressive with fiscal adjustments when unemployment/the output gap starts to rise as the costs of waiting- massive quantities of lost output and negative externalities, particularly with regard to the lives of those punished by the government allowing aggregate demand to decline- are far higher than, worst case, a period of ‘excess demand’ that can also readily be addressed with fiscal policy.

Lesson 9: Never forget the eternal verities lessons from the IMF. A country that manages itself well in normal times is likely to be better equipped to deal with the consequences of a crisis, and likely to emerge from it at lower cost.

Thus, we should continue to believe in the good housekeeping rules that the IMF has tirelessly promoted. In normal times countries should maintain fiscal discipline and monetary and financial stability. At all times they should take into account the need to follow sustainable growth-promoting macro- and structural policies. And they need to have a decent regard for the welfare of all segments of society.

Yes, at all times they should sustain full employment policy as the real losses from anything less far exceed any other possible benefits.

The list is easy to make. It is more difficult to fill in the details, to decide what policies to
follow in practice. And it may be very difficult to implement such measures, particularly when times are good and when populist pressures are likely to be strong. But a country that does not do so is likely to pay a very high price.

Lesson 10.

In a crisis, central bankers will often find themselves deciding to implement policy actions they never thought they would have to undertake and these are frequently policy actions that they would have preferred not to have to undertake. Hence, a few final words of advice to central bankers (and to others):

Lesson for all bankers:
Proposals for the Banking System, Treasury, Fed, and FDIC

Never say never


II. The Wisdom of My Teachers

:(

Feel free to distribute, thanks.

Over the years, I have found myself remembering and repeating words of advice that I first heard from my teachers, both academics and policymakers. Herewith a selection:


1. Paul Samuelson on econometric models: I would rather have Bob Solow than an econometric model, but Id rather have Bob Solow with an econometric model than Bob Solow without one.

2. Herb Stein: (a) After listening to my long description of what was happening in the Israeli economy in 1985: Yes, but what do we want them to do?”

(b) The difference between a growth rate of 2% and a growth rate of 3% is 50%.

(c) If something cannot go on forever, it will stop.
3. Michel Camdessus (former head of the IMF):

(a) At 7 a.m., in his office, on the morning that the U.S. government turned to the IMF to raise $20 billion by 9:30 a.m: Gentlemen, this is a crisis, and in a crisis you do not panic

(b) When the IMF was under attack from politicians or the media, in response to my asking Michel, what should we do?, his inevitable answer was We must do our job.

(c) His response when I told him (his official title was Managing Director of the IMF) that life would be much easier for all of us if he would only get himself a cell phone: Cell phones are for deputy managing directors.

(d) On delegation: In August, when he was in France and I was acting head of the IMF in Washington, and had called him to explain a particularly knotty problem and ask him for a decision, You have more information than me, you decide.

4. George Shultz: This event happened in May 1985, just before Herb Stein and I were due to leave for Israel to negotiate an economic program which the United States would support with a grant of $1.5 billion. I was a professor at MIT, and living in the Boston area. Herb and I spoke on the phone about the fact that we had no authorization to impose any conditions on the receipt of the money. Herb, who lived in Washington, volunteered to talk to the Secretary of State to ask him for authorization to impose conditions. He called me after his meeting and said that the Secretary of State was not willing to impose any conditions on the aid.

We agreed this was a problem and he said to me, Why dont you try. A meeting was hastily arranged and next morning I arrived at the Secretary of States office, all ready to deliver a convincing speech to him about the necessity of conditionality. He didnt give me a chance to say a word. You want me to impose conditions on Israel? I said yes. He said I wont. I asked why not. He said Because the Congress will give them the money even if they dont carry out the program and I do not make threats that I cannot carry out.

This was convincing, and an extraordinarily important lesson. But it left the negotiating team with a problem. So I said, That is very awkward. Were going to say To stabilize the economy you need to do the following list of things. And they will be asking themselves, and if we dont? Is there anything we can say to them?

The Secretary of State thought for a while and said: You can tell them that if they do not carry out the program, I will be very disappointed.

We used that line repeatedly. The program was carried out and the program succeeded.

Thank you all very much.

[1] Council on Foreign Relations. These remarks were prepared for presentation on receipt of the SIEPR (Stanford Institute for Economic Policy Research) Prize at Stanford University on March 14, 2014. The Prize is awarded for lifetime contributions to economic policy. I am grateful to Dinah Walker of the Council on Foreign Relations for her assistance.

[2] I draw here on two papers I wrote based on my experience in the IMF: Ten Tentative Conclusions from the Past Three Years, presented at the annual meeting of the Trilateral Commission in 1999, in Washington, DC; and the Robbins Lectures, The International Financial System: Crises and Reform Several other policy-related papers from that period appear in my book: IMF Essays from a Time of Crisis (MIT Press, Cambridge, MA, 2004). For the period of the Great Recession, I draw on Central bank lessons from the global crisis, which I presented at a conference on Lessons of the Global Crisis at the Bank of Israel in 2011.

[3] This point was made in my 1999 statement Ten Tentative Conclusions referred to above, and has of course received a great deal of focus in analyses of the Great Recession.

[4] Carmen Reinhart and Kenneth Rogoff, This Time is Different, Princeton University Press, Princeton, NJ, 2009.

Continues to look to me like the blip in November was from the likes of expiring tax incentives, and that growth fell off in 2013 and at least so far remains flattish, though the weather story won’t clear for another couple of months or so. Same with cars. And real disposable personal income growth near 0 as well.

Housing Starts

Highlights
Housing starts came in much as expected for February but permits topped the consensus forecast. Overall starts nudged down 0.2 percent to a 907,000 annual rate from an upwardly revised 909,000 rate for January which followed a downwardly revised December number of 1.024 million. Analysts expected 910,000 units for February. January and December previously were 880,000 and 1.048 million, respectively.

Single-family starts rose 0.3 percent after a 13.2 percent plunge in January. Multifamily starts dipped 1.2 percent in February after a 7.6 percent decline the month before.

Overall permits jumped 7.7 percent to a 1.018 million unit pace after decreasing 4.6 percent in January. Expectations were for 960,000. The increase was largely from a 24.3 percent spike in multifamily units while single-family permits eased 1.8 percent in both February and January.

U.S. factories flex muscle after severe winter chill

March 17 (Reuters) — U.S. manufacturing output recorded its largest increase in six months in February. Factory production increased 0.8 percent in February after a 0.9 percent January drop.

Quite the bounce- not even back to where it was.

Motor vehicle output rebounded 4.8 percent last month after tumbling 5.2 percent in January, the Fed said in its report.

Same.

There were also notable gains in the production of machinery and fabricated metal products. Mining output rose 0.3 percent last month, but utilities production fell 0.2 percent. The rise in manufacturing and mining output helped to lift overall industrial production 0.6 percent in February. It had slumped 0.2 percent in January. The amount of industrial capacity in use increased to 78.8 percent in February from 78.5 percent. Still, it remained 1.3 percentage points below its long-run average.

Renzi tells Merkel Italy will respect EU budget rules

March 17 (Reuters) — Italian Prime Minister Matteo Renzi on Monday assured German Chancellor Angela Merkel that he aimed to accelerate growth while respecting deficit spending limits.

:(

Renzi last week announced a sweeping package of tax cuts, including 10 billion euros ($13.9 billion) in income-tax reductions, to help spur consumer demand, saying spending cuts and extra borrowing would fund the measures.

Since spending cuts tend to be higher multiple than tax cuts, doesn’t seem all this is likely to help, and might hurt.

“Italy is not asking to exceed treaty limits,” Renzi told reporters after his a meeting with Merkel in Berlin.

They are still a bit above the 60% debt/gdp limit…

On top of the income-tax cuts, Renzi said he would reduce a regional business tax and increase hiring flexibility for companies. Renzi said Italian debt has risen as a percentage of output in recent years even though spending has been kept in check because growth has been stagnant. Domestic demand has “collapsed,” he said.

Empire State Mfg Survey

Highlights
Steady but slow is the indication from the Empire State index which is up slightly this month, to 5.61 from 4.48 in February. New orders also show a slight increase, to 3.13 vs last month’s slightly contractionary reading of minus 0.21, as do shipments, at 3.97 vs 2.13. Growth in the sample’s employment reading slowed, to 5.88 from 11.25.

Other readings include a rise in inventories and a sizable draw in backlog orders. Price readings, despite this month’s rise in fuel costs, show easing pressure. Readings on the six-month outlook are a little less optimistic than prior months.

Full size image

This always seems to chug along at about 3% and doesn’t say much about anything else:

Industrial Production

Highlights
Capacity utilization Consensus Forecast for February 14: 78.6 percent
Range: 78.4 to 78.8 percent

Industrial production was unexpectedly strong in February and utilities actually tugged down on the latest number. Industrial production rebounded 0.6 percent after dipping 0.2 percent in January. Market expectations were for a 0.3 percent gain.

By major components, manufacturing jumped 0.8 percent in February, following a 0.9 percent drop the month before. Mining rose 0.3 percent, following a 0.5 percent boost in January. Utilities slipped 0.2 percent after a 3.8 percent surge the prior month.

Full size image

So the challenge for 2014, at least so far, is to overcome drops in the growth of autos and housing vs 2013:

Housing Market Index

Highlights
The housing market index failed to bounce back much from February’s record loss, coming in at a lower-than-expected 47 for only a 1 point gain. Details for March once again show serious weakness in traffic, at 33 vs February’s 31. Weakness in traffic points to a lack of first-time buyers and underscores the continued importance of all cash buyers in the housing market.

Other details are on the plus side of 50 to indicate monthly growth but just barely, at 52 for current sales and 53 for future sales. The regional breakdown shows little separation except for the Northeast which lags badly but which however is by far the smallest region for new homes.

New home sales, which had been badly depressed, surged in January but this report points only to incremental growth for February and March. And the traffic component of this report points to a lack of sales growth in the months ahead. Watch for housing starts and permit data tomorrow morning on the Econoday calendar, both of which are expected to bounce back.

Reads more and more like they are paving the way for it to go down to ‘rejoin’ the rest of the EM’s and Japan etc?

The reason they give for it not going down is their fx reserves which could be used as a buffer. That implies it goes down otherwise?

“There is no basis for big appreciation of the renminbi,” the PBOC said, noting that China’s trade surplus now represents only 2.1% of its gross domestic product. At the same time, “there is no basis for big depreciation of renminbi,” the central bank added, saying that risks in China’s financial system are “under control” and the country’s big foreign-exchange reserves can serve as a big buffer against any external shocks. While pledging to give the market a bigger role in setting the yuan’s exchange rate, the PBOC said it would still implement “necessary adjustments” to prevent big, abnormal fluctuations in the yuan’s exchange rate.

As previously discussed, the ‘missing piece’ from the standard export model is buying the currency of your target market, as Germany used to do, and as the EU can’t do for ideological reasons- they don’t want to give the appearance that dollar reserves back the euro, and they want the euro to be the reserve currency. And they want to net export… whatever!

Spanish Central Bank Joins Chorus of Concern Over Euro’s Strength

By Paul Hannon

March 12 (WSJ) — In a news conference Thursday after the ECB’s decision to leave its policy unchanged, the bank’s president Mario Draghi said the euro’s 9% appreciation against the U.S. dollar since mid-2012 had been “a factor that is affecting in a significant way” the inflation rate, likely responsible for lowering it by almost half a percentage point. SpeakingMonday, Bank of France Governor Christian Noyer—who also sits on the ECB’s governing council—said that a strong euro lowers the inflation rate. “We are clearly not very happy at the moment,” he said.On Wednesday, Bank of Spain Governor Luis Maria Linde joined the chorus, making an explicit connection between the currency’s gains and possible future action by the ECB. “A stronger euro may lead to an easier policy, or a drop in inflation,” said Mr. Linde said. “We would like to have a little bit more inflation in the euro zone.”

Worse than expected, and only one number subject to revision, with the govt deficit at only 3% of GDP this kind of slowdown can turn pro cyclical:

Wholesale Trade

Highlights
Rising inventories, tied in part to weather-related shipping snags, are a rising threat to economic growth. Wholesale inventories rose 0.6 percent in January against a 1.9 percent plunge in sales, a heavy mismatch that drives the sector’s stock-to-sales ratio up 2 notches to 1.20 which is one of the heaviest readings of the recovery.

Details show large builds in autos, metals, and machinery, three groups where January sales were weak. Nondurable goods show especially large builds against especially soft sales including paper, drugs and petroleum.

Data on factory inventories, which were released last week with the factory orders report, showed an unwanted build and a dip in sales that pushed the stock-to-sales ratio near its heaviest level of the whole recovery. Inventories in the retail sector, with December the latest available report, are the heaviest of the recovery and are building at a time when sales are slowing — not accelerating. Retail data for January will be posted with the business inventories report on Thursday.

Market Consensus before announcement
Wholesale inventories showed a 0.3 percent build in December and were well matched by a 0.5 percent rise in wholesale sales that left the stock-to-sales ratio for the wholesale sector unchanged at 1.17. This ratio has held between 1.18 and 1.17 since May.

May be a fundamental shift in trade flows?

They don’t want to spend fx to defend?

Looking to let it go to get back to where it was vs yen at 80/$ as other EM’s seem to be doing?

China Weakens Yuan by Largest Degree Since 2012

By Anjani Trivedi

March 10 (WSJ) — The People’s Bank of China set the daily reference rate Monday at 6.1312 to the dollar, compared with 6.1201 to the dollar on Friday. The 0.18% change represented the largest one-day move in the rate since July 2012. The central bank determines the rate each day, and then allows the currency to trade as much as 1% higher or lower. Since 2005, it has gradually moved the rate up, allowing the yuan to strengthen 33%, but in the last month has pushed it lower, seeking to discourage speculators who have channeled money into the economy in hopes of benefiting from the currency’s rise. On Monday, the yuan touched 6.1458 against the dollar, compared with 6.1260 late Friday in New York. The offshore yuan, which is freely traded outside China, weakened as far as 6.1309 from a closing level of 6.1095 on Friday. Premier Li Keqiang said last week at the National People’s Congress, China’s annual legislative session, that Beijing would expand the currency-trading band.

Weather worse than expected.
;)

This is a lesser indicator that only matters if it goes up…
;)

NFIB Small Business Optimism Index

Highlights
The small business optimism index, which had been on a rebound, fell sharply in February, down 2.7 points to 91.4. A weakening in sales expectations pulled the index down the most followed by economic expectations and hiring plans.Respondents continue to reduce inventories and are reporting no more than limited pricing power.

Mind the gap:

This is below prior recession levels!

This is year over year growth in consumption of domestic product, which is GDP less capex less exports.

It shows how much ‘the consumer’ is spending on domestically produced goods and services:

The underlying narrative is that proactive austerity damages income growth and thereafter requires a ‘jump’ in ‘borrowing to spend’/reduction in savings’ to sustain the prior levels of growth.

When growth itself brings the govt deficit down via the auto fiscal stabilizers, the needed credit growth/savings drop to replace the lost govt deficit spending is ‘already there proactively’ as it’s what drove the growth in the first place. So while the credit expansion/savings reduction needs to continue to grow to support GDP growth, the credit expansion/savings reduction doesn’t need to ‘spike up’ proactively as it does when the fiscal tightening is proactive.

So note that q3′s higher GDP growth included over 1% from additions to inventories. That represents a reduction in corporate savings from what it would have been if they had not net added to inventories. That is, consumers didn’t ‘jump the gap’ created by the ongoing increase in FICA vs the prior year, and the sequester cuts, that together proactively reduced govt deficit spending by over 1.5% of GDP (with the FICA hike adding to the automatic stabilizers as well). And Q4′s consumer spending on domestic product grew at a lower rate even as capex was higher. Also note that while capex growth for 2014 is forecast at about the same 5% as 2013, even with the high levels of energy investments, ultimately it’s largely a function of top line sales.

The reduction in net imports is a reduction in the growth of foreign savings of $ denominated financial assets, which does ‘make up’ for the reduction in govt deficit spending, depending on foreign demand. But it’s been ongoing and doesn’t look to be ‘jumping the spending gap.’

And note too that the running US deficit of about 3% of GDP is about the same as the euro zone’s and the Maastricht limit. So for me the question is whether this will make our economies converge as US income growth continues to decline?

And, as previously discussed, the 0 rate policy has worked to directly bring down personal income. Also note that personal income growth has slowed coincidentally with the approx 200,000/mo additions to total employment.

So seems that the income added by that much new employment isn’t enough to keep overall (after tax) personal income growth positive.

Weather related…
;)

Evidence that small business lending has improved is piling up. Banks had $287.64 billion in outstanding loans to small businesses as of Dec. 31, up 1.4 percent from a year earlier, according to the Federal Deposit Insurance Corp. In January, the dollars loaned to small businesses by banks, independent commercial finance companies and corporations, increased 4 percent from last year, according to Thomson Reuters and PayNet. And a February survey by Pepperdine University’s Graziadio School of Business and Management found that 39 percent of small business owners who applied for bank loans in the previous three months were successful, up from 34 percent in a survey taken in October and November.

Net personal interest income not yet growing as during prior cycles.

Doesn’t happen until after the Fed hikes…
;)

Interest income

Personal interest payments

Highlights
Frigid weather in January didn’t help the factory sector where orders fell 0.7 percent following a downwardly revised 2.0 percent decline in December. Also revised lower is the ex-transportation reading for January, to a slim plus 0.2 percent vs an initial reading (in last week’s durable goods report) of plus 1.1 percent. Non-durables are the new data in today’s report which show a 0.4 percent decline on weakness in chemical products.

Orders for primary metals show a third month of contraction, at minus 1.2 percent in January, with transportation equipment a second month of contraction, at minus 5.7 percent vs a 12.1 percent plunge in December. The bulk of the weakness in transportation is tied to the ups and down of commercial aircraft orders but also to motor vehicles, where orders fell 0.9 percent following December’s 1.2 percent decline. Machinery also shows a decline in January along with electrical equipment and furniture, the latter two of which are tied to housing. The plus side shows a big gain for fabricated metals, one however that follows a big loss in December, and a gain for computer equipment that doesn’t offset a much larger December decline.

Shipments fell 0.3 percent for a second month in a row while inventories rose 0.2 percent, a moderate build but enough, given the weakness in shipments, to raise the inventory-to-shipments ratio one notch to the heavy side to 1.30. Unfilled orders were unchanged in the month.

There is a positive in the report and that’s capital goods orders excluding aircraft, a core reading on business investment that rose 1.5 percent. Still, the gain isn’t enough to offset a 1.6 percent decline for this reading in the prior month.

Factory orders are a choppy series, sometimes up and sometimes down, but the trendline has been flat at best. Anecdotal indications on February point to another month of weakness for shipments, weakness tied to heavy weather, but, in what hopefully points to a bounce back for the spring, respectable strength for orders.

Chart looks like the weather turned bad in May:

Lots of talk about ‘wage inflation’ but not showing up for real so far:

Highlights
Productivity in the fourth quarter rose a revised1.8 percent after a 3.5 percent boost the prior quarter. Expectations were for 2.4 percent increase. Unit labor costs declined an annualized 0.1 percent, following a decrease of 2.1 percent in the third quarter. The market forecast was for a 0.5 percent decline.

The rise in productivity reflected a 3.4 percent jump in non-farm output, following a boost of 5.4 percent in the third quarter. Hours worked increased 1.6 percent in the fourth after rising an annualized 1.9 in the third quarter. Compensation firmed to a 1.7 percent rate after rising 1.3 percent in the third quarter.

Year-on-year, productivity was up 1.3 percent in the fourth quarter versus up 0.5 percent in the third quarter. Year-ago unit labor costs were down 0.9 percent, compared to up 1.9 percent in the third quarter.

Prior months revised down as well:

ADP:

MBA Purchase Applications:

Highlights
Wild swings appear to be the rule for weekly mortgage application data. The purchase index jumped 9.0 percent in the February 28 week following declines of 4.0 percent and 6.0 percent in the two prior weeks. Though the latest week is higher, the year-on-year rate fell 4.0 percentage points to minus 19 percent. The refinance index jumped 10.0 percent in the week following an 11.0 percent decline in the prior week.

The latest week got a lift from a drop in mortgage rates, down 6 basis points for 30-year conforming mortgages ($417,500) to an average 4.47 percent.

It’s hard to make much of this report, but the year-on-year rate for purchase applications does point to continued weakness for home sales.

In particular, there was a significant drop in the employment index, which plunged 8.9 points to 47.5. This is its lowest level since 2010 and commentary from respondents suggests that some of this effect could be due to the implementation of the Affordable Care Act.

Outside of the employment index, however, the new orders index climbed to 51.3 (previous: 50.9), and the headline index has now remained above the breakeven level of 50 for 49 consecutive months. Overall we would suggest that this is a softer report than January, but we do not yet think that it marks a significant slowdown in the pace of nonmanufacturing activity growth.

Note export orders down again.

Forecasters have been counting on an increase in export growth:

Lawler on Hovnanian: Net Home Orders Far Short of Expectations; Sales Incentives Coming

By Bill McBride

March 5 — From housing economist Tom Lawler:

Hovnanian Enterprises, the nations sixth largest home builder in 2012, reported that net home orders (including unconsolidated joint ventures) in the quarter ended January 31, 2014 totaled 1,202, down 10.6% from the comparable quarter of 2013. The companys sales cancellation rate, expressed as a % of gross orders, was 18% last quarter, up from 17% a year ago. Home deliveries last quarter totaled 1,138, down 4.2% from the comparable quarter of 2013, at an average sales price of $351,279, up 6.1% from a year ago. The companys order backlog at the end of January was 2,438, up 6.0% from last January, at an average order price of $368,243, up 4.3% from a year ago.

Hovnanians net orders in California plunged by 43.4% compared to a year ago. Hovnanians average net order price in California last quarter was $653,366, up 46.8% from a year ago and up 83.2% from two years ago. Net orders in the Southwest were down 10.0% YOY.

Here is an excerpt from the companys press release.

“While our first quarter is always the slowest seasonal period for net contracts, the strong recovery trajectory from the spring selling season of 2013 has softened on a year-over-year basis. Net contracts in the months of December, January and February have not met our expectations. In addition to the lull in sales momentum, both sales and deliveries were impacted by poor weather conditions and deliveries were further impacted by shortages in labor and certain materials in some markets that have extended cycle times,” stated Ara K. Hovnanian, Chairman of the Board, President and Chief Executive Officer.

“We are encouraged by the fact that we have a higher contract backlog, gross margin and community count than we did at the same point in time last year. Furthermore, we have taken steps to spur additional sales in the spring selling season, including the launch of Big Deal Days, a national sales campaign during the month of March. Our first quarter has always been the slowest seasonal period and we expect to report stronger results as the year progresses. We believe this is a temporary pause in the industry’s recovery, and based on the level of housing starts across the country, we continue to believe the homebuilding industry is still in the early stages of recovery,” concluded Mr. Hovnanian.

Plus airfare, hotel, meals, airport limo, etc. ;):

Bernanke received at least $250,000 for his appearance at the financial conference staged by National Bank of Abu Dhabi, the UAE’s largest bank, according to sources familiar the matter. NBAD did not announce the fee.

Because of Abu Dhabi’s oil wealth, state-controlled NBAD prospered during the global crisis caused by Lehman’s collapse, taking market share from hard-hit U.S. and European banks.

Bernanke’s speaking fee is similar to one received by his predecessor Alan Greenspan for an Abu Dhabi speaking engagement in 2008, the sources said.

Greenspan embarked on a series of lucrative speeches after he stepped down, and Bernanke now appears to be doing the same. He is scheduled to speak at an event in South Africa on Wednesday and in Houston on Friday.

Seems to me it must be a nation of counterfeiters for the UK govt from inception to get its funds from the people…

Not that the author isn’t also confused by the ‘money creation dynamics.’

It’s Official: There Is a Money Tree

“…Cameron echoed his predecessor Margaret Thatcher, who in October, 1983 told the Conservative Party conference that:

“the state has no source of money, other than the money people earn themselves. If the state wishes to spend more it can only do so by borrowing your savings, or by taxing you more. And it’s no good thinking that someone else will pay. That someone else is you.

There is no such thing as public money. There is only taxpayers’ money”.

This idea that “there is no such thing as public money” was later foolishly echoed by Labour’s Treasury spokesperson, Liam Byrne. He left a note for his successor upon leaving the Treasury in 2010 which said: “I’m afraid there’s no money left.”