Category Archives: Inflation

Financial Repression Coming to America: El-Erian

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Unfortunately, I can’t say that policy makers with as little understanding of actual monetary as he has won’t do that type of thing.

(Nor can’t I say he isn’t talking position)

I can say they all seem heck bent on deficit reduction, which is probably the most severe and effective form of economic repression.

And $US short covering, in its various forms,
which may already be in the early stages as suggested in previous posts,
should reveal any underlying deflationary forces of repression.

Financial Repression Coming to America: El-Erian

May 17 (CNBC) — The co-CEO of the world’s largest bond fund has warned America that it faces a combination of higher inflation, austerity and financial repression over the coming years as policy makers grapple with the impact of the financial crisis and the subsequent policy response.

“Think of the debt overhangs in advanced economies where projected rates of economic growth are not sufficient to avoid mounting debt and deficit problems,” said Mohamed A. El-Erian in speech at a PIMCO forum on growth.

“Some are already flashing red, and they will force even more difficult decisions between restructuring and the massive socialization of losses, like Greece,” he added.

“Others are flashing orange, like the US, and already require future sacrifices, most likely through a combination of higher inflation, austerity and, importantly, financial repression,” said El-Erian, who classifies financial repression as seeking to impose negative real rates of returns on savers.

This policy will undermine the real return contract offered to savers and, in El-Erian’s view, come instead of any bold moves to address structural problems and imbalances.

“Secular baseline portfolio positioning should minimize exposure to the negative impact of financial repression, hedge against higher inflation and currency depreciation and exploit the heightened differentiation in balance sheets and growth potentials,” El-Erian added.

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QE2: Captain, your ship is sinking

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So imagine the corn crop report comes out and it surprises on the upside at up 30%
What happens? The price of corn probably starts to fall. Commercial buyers back off, farmers rush to hedge, and, overall, players of all ilks try to reduce positions, get short, etc.

A few weeks later it’s further confirmed that the farmers are producing a massive bumper crop.

What happens? The same adjustments continue.

But what if that crop report was wrong? What if, in actual fact, there had been a crop failure? And market participants never do get that information?

What happens? Prices go down for a while as described above, but at some point they reverse, as sellers dry up, and as consumption overtakes actual supply price work their way higher, and then accelerate higher, even if no one ever actually figures out there was a crop failure.

QE is, in fact, a ‘crop failure’ for the dollar. The Fed’s shifting of securities out of the economy and replacing them with clearing balances removes interest income. And the lower rates from Fed policy also reduces interest paid to the economy by the US Treasury, which is a net payer of interest.

But the global markets mistakenly believed QE was producing a bumper crop for the dollar. They all believed, and some to the of panic, that the Fed was ‘printing money’ and flooding the world with dollars.

So what happened? The tripped overthemselves to rid them selves of dollars in every possible manner. Buying gold, silver, and the other commodities, buying stocks, selling dollars for most every other currency, selling tsy securities, etc. etc. etc. in what was, in most ways, all the same trade.

This went on for months, continually reinforced by the pervasive rhetoric that QE was ‘money printing’, and that the Fed was playing with fire and risking hyperinflation, with the US on the verge of suddenly/instantly becoming the next Greece and getting its funding cut off.

Not to mention Congress with it’s deficit reduction phobia.

So what’s happening now? While everyone still believes QE is a bumper crop phenomena, QE (and 0 rate policy in general) is none the less an ongoing crop failure, continuously removing $US net financial assets from the economy.

And so now that the speculators and portfolio shifters have run up prices of all they tripped over each other to buy, the anticipated growth in spending power-underlying aggregate demand growth needed to support those prices- isn’t there. And, to throw more water on the fire, the higher prices triggered supply side repsonse that have increased net supply along with a bit of ‘demand destruction’ as well.

Last week I suggested that higher crude prices were the last thing holding down the dollar, and that as crude started to fall I suggested its was all starting to reverse.

It’s now looking like it’s underway in earnest.

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German Exports Surged to Record in March, Boosting Growth

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“The German government predicts economic growth of 2.6 percent this year after a record 3.6 percent expansion in 2010. The country will regain its place as the world’s second- biggest goods exporter in 2011 after being overtaken by the U.S.”

Interesting perspective.

3.6% is pretty low for a record year, and this year looks to be lower than last even with ‘booming exports’

It’s all a sign of low aggregate demand, particularly with the growth of 0 marginal cost infinite leverage output such as software, music, and video which is simply downloaded. There is no ‘speed limit’ for that kind of thing, so directed accordingly, non inflationary GDP can grow at any rate.

German Exports Surged to Record in March, Boosting Growth

By Jana Randow

May 9 (Bloomberg) — German exports surged in March to the highest monthly value ever recorded, boosting growth in Europe’s largest economy.

Exports, adjusted for work days and seasonal changes, jumped 7.3 percent from February, when they gained 2.8 percent, the Federal Statistics Office in Wiesbaden said today. Economists had forecast a 1.1 percent increase, according to the median of 10 estimates in a Bloomberg News survey. Exports were worth 98.3 billion euros ($141.4 billion) in March, the most since records began in 1950, the statistics office said.

Germany’s economic recovery is broadening as companies boost investment and hiring to meet booming export demand from emerging Asia. The economy may have expanded as much as 1 percent in the first three months of the year and may maintain its growth momentum in the current quarter, according to the Bundesbank.

“The German economy continues to power ahead,” said Holger Schmieding, chief economist at Berenberg Bank in London. “After a very strong start to 2011, Germany may lose a little steam over the summer.”

The euro rose almost half a cent after the report to $1.4424 at 8:16 a.m. in Frankfurt.

Record Imports

From a year earlier, exports rose 15.8 percent, today’s report showed. Imports advanced 16.9 percent in the year and 3.1 percent from February. Worth 79.4 billion euros in March, imports also reached a record monthly value.

The trade balance widened to 18.9 billion euros from 11.9 billion euros in February. The surplus in the current account, a measure of all trade including services, was 19.5 billion euros in March, up from 8.7 billion euros in February.

Germany’s BASF SE, the world’s biggest chemical company, reported a 40 percent jump in first-quarter earnings last week and Siemens AG, Europe’s largest engineering company, said profit this year will rise at least 75 percent.

The German government predicts economic growth of 2.6 percent this year after a record 3.6 percent expansion in 2010.

The country will regain its place as the world’s second- biggest goods exporter in 2011 after being overtaken by the U.S. last year due to exchange-rate movements, the Ifo economic institute said on April 19.

“In times of investment catching up in the emerging world, infrastructure renewals in the western world and a general shift of energy policies toward alternative and renewable energies, German industry simply offers the right mix,” said Carsten Brzeski, senior economist at ING Group in Brussels.

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Geithner- U.S. Will Urge China to Boost Interest Rates

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Even more confused than the usual out of paradigm nonsense from Geithner highlighted below:

U.S. Will Urge China to Boost Interest Rates in Washington Talks

By Rebecca Christie and Ian Katz

May 9 (Bloomberg) — Treasury Secretary Timothy F. Geithner will urge China to allow higher interest rates when he meets with Chinese leaders this week, as the U.S. extends its push for a stronger yuan.

Geithner will say China should relax controls on the financial system, give foreign banks and insurers more access and make it easier for investors to buy Chinese financial assets, said David Loevinger, the Treasury Department’s senior coordinator for China. Officials from both nations are meeting in Washington today and tomorrow as part of the annual Strategic and Economic Dialogue.

The US Treasury shamelessly fronting for the financial sector.

The U.S. is pushing for greater market access for financial firms as part of its broader effort to persuade China to ease the restrictions blamed for fueling global imbalances. U.S. officials argue that a yuan kept artificially cheap to help exporters also makes it harder for China to lift interest rates and curb an inflation rate that hit a 32-month high in March.

Budget Deficits

Chinese officials, for their part, blame record U.S. budget deficits for contributing to lopsided global flows of trade and investment. China held $1.15 trillion in Treasuries at the end of February, more than any other country. The U.S. trade deficit with China came to $18.8 billion in February.

Vice Finance Minister Zhu Guangyao said on May 6 that China is paying “close attention” to U.S. efforts to reduce its budget deficit, and his country will focus on improving the quality of itsexchange-rate mechanism.

Yes, China is chiming in on US fiscal policy and no one of political consequence believes they are wrong.

Geithner and Vice Premier Wang Qishan will meet alongside Secretary of State Hillary Clinton and State Councilor Dai Bingguo at this week’s meetings, which will draw about 30 top Chinese officials.

The Obama administration and U.S. lawmakers say China’s currency policy gives the nation’s exporters an unfair competitive advantage, costing U.S. jobs. Geithner is trying to convince Chinese officials that a stronger yuan has benefits for their economy.

‘Enhanced’ Ability

Geithner said last week that allowing the yuan to rise and making their financial system less dependent on government- controlled interest rates would give Chinese leaders an “enhanced” ability to damp inflation.

This just gets stupider and stupider with each out of paradigm iteration.

The Treasury argues that higher interest rates on deposits will also encourage consumer spending in China, another way to reduce imbalances.

Here he takes my position on monetary policy- depending on the institutional structure, higher rates add to aggregate demand via the income interest channels. But it’s totally confused in this context of fighting inflation, as higher demand adds to price pressures, and also adds to cost pressures via the cost of capital for businesses.

“We’re going to encourage China to move more quickly in lifting the ceiling on interest rates on bank deposits in order to put more money into Chinese consumers’ pockets,” Loevinger said at a briefing last week in Washington.

Investors are betting the yuan’s rise may be limited over the next 12 months. Twelve-month non-deliverable yuan forwards dropped 0.81 percent last week to 6.3520 per dollar on May 6, their biggest weekly loss of the year, on speculation that China won’t allow faster appreciation to reduce inflation.

Fundamentally, inflation and currency depreciation are pretty much the same thing. So ultimately inflation goes hand in hand with currency depreciation, as inflation removes the ability to ‘allow faster appreciation’.

17-Year High

The yuan closed little changed in Shanghai on May 6, ending a run of seven weekly gains that drove the currency to a 17-year high of 6.4892 on April 29, according to the China Foreign Exchange Trade System.

John Frisbie, president of the U.S.-China Business Council, said support for a stronger yuan among Chinese leaders has increased in the past year.

Yes, looks like inflation is bad enough in their view to throw their exporters under the bus via currency appreciation (for as long as it can last) in what looks like a desperation move.

“The strong hand has switched over to those who are saying that the exchange rate can help us fight inflation,” Frisbie said in a telephone interview. He said his group, whose members include companies such as Apple Inc. (AAPL), JPMorgan Chase & Co. (JPM) and Coca-Cola Co. (KO), wants China to resume opening its financial services sector to allow more foreign investment.

The American Chamber of Commerce in China said in a report last month that foreign banks play an “insignificant role” in China.

Foreign lenders’ market share in China has dropped since the government first opened the industry in December 2006. Banks such as New York-based Citigroup Inc. (C) and London-based HSBC Holdings Plc (HSBA) want to tap household and corporate savings that reached $10 trillion in January as China overtook Japan to become the world’s second-biggest economy.

Foxes into the hen house…

Foreign Exchange

The U.S. has delayed its semi-annual foreign-exchange report, which had been due on April 15, until after this week’s meetings. The previous report, due on Oct. 15, 2010, was released on Feb. 4 and declined to brand China a currency manipulator while saying the No. 2 U.S. trading partner has made “insufficient” progress on allowing the yuan to rise.

The yuan goes beyond the U.S. and China to become “a multilateral issue, in terms of the impact on Brazil, Korea, Thailand and India,” said Edwin Truman, a former Federal Reserve and Treasury official who is now a senior fellow at the Peterson Institute for International Economics.

‘Causing Trouble’

The “slow” appreciation of the yuan “relative to the dollar in an environment where the dollar is going down against other currencies is causing trouble for other countries and currencies,” Truman said.

Diplomats at the Strategic and Economic Dialogue also will discuss events in the Middle East, including military operations in Libya and the ramifications of the region’s popular uprisings.

Officials are likely to discuss efforts to revive six-party talks on North Korea’s nuclear program. Negotiations between the two Koreas, Russia, Japan, China and the U.S. stalled in December 2008 and tensions flared on the peninsula after North Korea’s Nov. 23 bombing of a South Korean island.

Yes, mistakenly believing we are dependent on China to fund our deficit spending has us kowtowing on human rights and nuclear weapons.

“We want to compare notes on where we stand with respect to North Korea, and we will be very clear on what our expectations are for moving forward,” Kurt Campbell, assistant secretary of state for East Asia, said on May 5.

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Galbraith on federal debt sustainability

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Is The Federal Debt Unsustainable?

By Professor James K. Galbraith

Excerpt

A more prosaic problem with the runaway-inflation scenario is that the “nonpartisan, professional” economic forecasters of the Congressional Budget Office (CBO), whose work is often cited as the benchmark proof of an “unsustainable path,” do not expect it to happen. The CBO baseline resolutely asserts that inflation will stay where it is now: around 2 percent. So one can’t logically cite the inflation threat and the CBO baseline at the same time. So far as I know, the CBO does not trouble itself to model the exchange value of the dollar.

What the CBO does warn is that, under their assumptions, the ratio of US federal debt (held by the public) to GDP will rise relentlessly, passing 200 percent by 2035 and 300 percent by midcentury. Correspondingly, net interest payments on that debt would rise to exceed 20 percent of GDP. This certainly seems worrisome, and the CBO warns about “investor confidence” and “crowding out” without actually building these things into their model. Indeed, in their model this remarkable and unprecedented ratio of debt to GDP goes right along with steady growth, full employment, and low inflation, world without end! Why one should care about mere financial ratios if they produce such good—and, according to the CBO model— “sustainable” results is another mystery the CBO does not explain.

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ECB debt buying plan suffers fresh setback

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ECB debt buying plan suffers fresh setback

Another silly headline that completely misses the point of monetary operations.

The ‘debt buying plan’ is a purely technical move to do what is called ‘offset operating factors’ as a means to hitting the ECB’s interest rate targets.

The quantity of securities offered to do this is entirely inconsequential. As always, for a central bank, the monopoly supplier of net reserves for its currency of issue, it’s about price (interest rates) and not quantities. And the only possible ‘inflationary impact’ is via the interest rate channels:

(FT) — The European Central Bank faced embarrassment on Tuesday after failing for a second consecutive week to neutralise fully the inflationary impact of funds it had spent buying government bonds to combat the region’s debt crisis. On Tuesday, the ECB was due to reabsorb €76bn – the total amount spent under the bond-buying programme so far. But banks only offered €62bn. Last week, the ECB had also failed to reabsorb the required amount. In total, such operations have failed five times in the past year.

The latest setback was the result of higher market interest rates, which deterred banks from parking funds at the ECB. It could fuel ECB nervousness about its bond buying.

Europe Services, Manufacturing Growth Accelerated in April

(Bloomberg) — European services and manufacturing growth accelerated in April. A composite index based on a survey of euro-area purchasing managers in both industries rose to 57.8 from 57.6 in March, Markit Economics said. That’s in line with an initial estimate on April 19.

They call the above an acceleration, I suppose because it fell in March:

The euro-area services indicator fell to 56.7 from 57.2 in March, Markit said, below a preliminary reading of 56.9 released last month. The manufacturing gauge increased to 58 from 57.5. In Germany, which has fueled the region’s recovery, a manufacturing indicator rose to 62 from 60.9 in March, while a services gauge slipped to 56.8 from 60.1.

Europe Retail Sales Decline Most in Almost a Year on Oil

Note the ‘and government austerity measures’ didn’t make the headline:

(Bloomberg) — European retail sales declined the most in almost a year in March as higher oil prices and government austerity measures curbed consumer spending. Sales in the 17-nation euro region fell 1 percent from the previous month after a revised 0.3 percent increase in February. March sales dropped 1.7 percent from a year earlier. Among services companies, “expectations for their activity levels in 12 months’ time slipped for the second successive month to reach a six-month low,” Markit said in a report. German retail sales declined 2.1 percent in March from February, when they fell 0.4 percent, today’s Eurostat report showed. In France, sales dropped 1 percent. Spanish sales fell 1.4 percent, while Ireland saw a 0.6 percent increase.

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The other Warren (Buffet) gets MMT?

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Waiting for the day when he adds:

‘There for federal taxes function to regulate aggregate demand, and not to raise revenue per se.’

Warren Buffett: Failure to Raise Debt Limit Would Be ‘Most Asinine Act’ Ever By Congress

By Alex Crippen

April 30 (CNBC) — Warren Buffett says if Congress fails to raise the U.S. debt limit, it would be its “most asinine act” ever. But he told shareholders today there’s “no chance” lawmakers will fail to do so, despite “waste of time” debates on Capitol Hill.

While Buffett doesn’t want the nation to keep increasing its debt relative to GDP, he says there’s shouldn’t be a legislated debt limit to begin with, because circumstances change.

Buffett says the U.S. will not “have a debt crisis of any kind as long as we keep issuing our notes in our own currency.” Inflation resulting from a “printing press” approach, however, is a serious threat.

Charlie Munger’s view: the political parties are competing with each other to see who can be the most stupid, and they keep topping themselves.

If the debt limit is not raised, the government would run out of money, forcing a significant shutdown.

The current $14.3 trillion limit expires on May 16, although the administration has said it will be able to juggle some funds so that a shutdown would not happen immediately.

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how crowded is the short dollar trade?

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Long gold, stocks, and other currencies is all the same trade, and all the specs and trend followers are in big, proving once again that the crowd isn’t always wrong.

Lack of understanding of what QE actually is seems to have scared everyone from portfolio managers and the man on the street to Putin to take action.

And Chairman Bernanke’s recent remarks, though fundamentally sound, gave them no comfort whatsoever, and only encourage this latest round of dollar selling and related trades.

No telling how long it will keep going.

But underneath it all the dollar’s fundamentals aren’t all that bad relative to the other currencies, apart from rising crude prices keeping the US import bill higher than otherwise, though partially offset by higher export prices, including food.

At last look trade gaps look to be ‘deteriorating’ in the eurozone, the UK, Japan, Canada, and Australia, as their currencies continue to climb, indicating they may have gotten past the humps in their J curves and trade flows have turned against them?

So looks to me like with the entire dollar move predominately driven by ‘hot money’ in the broad sense, there is nothing fundamental to get in the way of the reversal scenario suggested at the end of this article.

Best way to play it? Stay out of the way.

Cheap Dollar Fuels One-Way Bets in Everything Else

By Reuters

April 28 (Bloomberg) — Americans’ cheap money spigot remains open and the flow is as fast as ever, meaning the world had better brace for even higher oil, metals and food prices and a weaker dollar.

The clear message from Federal Reserve Chairman Ben Bernanke on Wednesday was that the U.S. central bank intends to keep interest rates exceptionally low and monetary policy very easy as it continues to try to inflate the U.S. economy back to health.

For investors, he offered further encouragement to keep borrowing in dollars, paying virtually nothing and then swapping those dollars into higher-yielding currencies or using them to buy oil, metals and food futures and options.

This so-called “carry trade” has become the trade du jour, particularly with the dollar’s precipitous drop of around 10 percent from its peak in January.

By comparison, U.S. crude futures are up 23 percent so far this year and the Thomson Reuters-Jefferies CRB index, a global index of commodities, is up 10 percent.

“The biggest risk right now is that Bernanke’s looseness creates the unintended consequence of boom-goes-bust, where easy-money-driven asset bubbles implode and confidence is consequently sucked out of the economy,” said JR Crooks, chief of research at investment advisory firm Black Swan Capital in Palm City, Florida.

“It’s one thing to have a currency on the decline; it’s another thing to have GDP on the decline.”

The “carry” trading tack is akin to the still popular yen-carry trade, which involves borrowing yen at Japan’s near-zero interest rates to purchase other higher-yielding securities such as Treasuries. Investors are borrowing in currencies like the dollar to fund purchases in markets with higher yields or currencies with potentially higher returns.

The Barclays’ G10 carry excess return index shows that borrowing in low-yielding currencies such as the greenback and buying those with high interest rates like the Australian dollar has generated returns of about 37 percent so far since the end of the financial crisis in early 2009.

“The Fed seems to be in no rush to tighten monetary policy. So if rates remain low, why shouldn’t the dollar be the preferred funding currency?” said Thomas Stolper, chief currency strategist at Goldman Sachs in London.

“And as you know in foreign exchange, it’s all about differentials between countries and in that respect, that differential is negative for the dollar,” Stolper added.

The yield differential continues to weigh against the dollar, particularly against the euro , the Australian dollar, and some emerging market currencies, whose central banks have started to raise interest rates.

Record low U.S. rates of zero to 0.25 percent, an enormous supply of liquidity under the Fed’s purchases of more than $2 trillion of Treasury and mortgage bonds, and improving economic prospects in emerging markets have prompted investors to borrow the lower-yielding dollar in carry trades over the last 18 months.

A rough estimate from investment advisory firm Pi Economics in Stamford, Connecticut, showed that the Fed’s easing may have fueled dollar carry trades in excess of $1 trillion, based on U.S. financial institutions’ net foreign assets positions.

On Wednesday, the dollar skidded to a three-year low of 73.284 as measured by the Intercontinental Exchange’s dollar index, down around 10 percent from its peak in January. Many traders expect the index to fall through the all-time low, hit in July 2008, of 70.698.

Feasible Alternative

For some investors, using the dollar in carry trades remains the only feasible alternative to other low-yielding currencies such as the yen and Swiss franc .

While the yen yields an interest rate of zero, like the dollar, the Japanese currency could strengthen if the economy goes into recession. Since Japan has huge overseas investments, a recession would prompt a repatriation of domestic investors’ funds to bolster savings, boosting the yen.

The Swiss economy is in much better shape than the United States and a rise in inflation there could well prompt the Swiss National Bank to raise interest rates, much like the European Central Bank did early this month.

That leaves the U.S. dollar as the only other option left to finance investors’ penchant for risk-taking.

“No one really thinks the Fed will hike rates significantly … They would want to keep rates low since the recovery is not that strong,” said Pablo Frei, a portfolio manager and senior analyst at Quaesta Capital, a Zurich-based fund of funds focused on currency managers, with assets under management of about $3.5 billion.

Frei said that although the dollar is a big short among hedge funds, “people have become more cautious of the risk of the dollar carry,” given how crowded this trade has become.

He added that the fund managers he tracks have reduced their short position on the dollar, although the lower-dollar bet remains their largest exposure.

As in any crowded trade, there is always the risk of a squeeze once things get sour, which could lead to a massive unwinding of carry trades and the potential for huge losses for those slow to get out. When global stocks drop, or when the risk barometer shoots up, investors tend to repatriate funds, close out losing carry trades and buy back currencies they had shorted.

This happened in 2008 during the global financial crisis and could well happen again.

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An other-paradigm bludgeon?

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>   
>   (email exchange)
>   
>   On Fri, Apr 29, 2011 at 10:10 AM, Arthur Patten wrote:
>   
>   Warren, just came across this 2008 paper. Authors find that most of the volatility in
>   standard inflation measures is due to relative price changes and that interest rates
>   are positively correlated with inflation. On behalf of the authors, you’re welcome!
>   

RELATIVE GOODS’ PRICES, PURE INFLATION, AND THE PHILLIPS CORRELATION

By Ricardo Reis and Mark W. Watson

August 2008

Department of Economics, Columbia University
Department of Economics and Woodrow Wilson School, Princeton University

Abstract (excerpts below): This paper uses a dynamic factor model for the quarterly changes in consumption goods’ prices to separate them into three independent components: idiosyncratic relative-price changes, a low-dimensional index of aggregate relative-price changes, and an index of equiproportional changes in all inflation rates, that we label “pure” inflation. The paper estimates the model on U.S. data since 1959, and it presents a simple structural model that relates the three components of price changes to fundamental economic shocks. We use the estimates of the pure inflation and aggregate relative-price components to answer two questions. First, what share of the variability of inflation is associated with each component, and how are they related to conventional measures of monetary policy and relative-price shocks? We find that pure inflation accounts for 15-20% of the variability in inflation while our aggregate relative-price index accounts most of the rest. Conventional measures of relative prices are strongly but far from perfectly correlated with our relative-price index; pure inflation is only weakly correlated with money growth rates, but more strongly correlated with nominal interest rates. Second, what drives the Phillips correlation between inflation and measures of real activity? We find that the Phillips correlation essentially disappears once we control for goods’ relative-price changes.

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