Alright so the Fed isn't going to defend the 10yr at 3%, and in fact appears to be targeting the belly of the yeild curve. That doesn't change the fundamental problem of deflation. Near term, based entirely on technicals, I've made a small short play in Treasuries. But I'm really just looking for a new entry on the long-side.
Almost exactly 2-years ago, I made my now famous (in my own mind) analogy of inflation to a Monopoly game. Basically my point was inflation wasn't about the price of any given property (or good) but the price of all the properties. Allowing any given good (at the time it was energy) to rise isn't, in and of itself, inflation.Now there is fear that the Fed and Treasury's activities, especially the Fed's recent panache for "crediting bank reserves" (which means printing money). Here is the chart for M1 and M2 up 14% and 9% respectively in the last year.
Back to my Monopoly analogy. We might think of the M's as the actual multi-colored cash that each player has. As I demonstrated two years ago, an increase in cash available should cause the price level to rise, but only if you hold the savings rate constant.
Speaking more technically, you could say that an increase monetary base would have some multiplied impact on transactable money. In your textbook from college, this only involved banks and their willingness to lend. Actually, most often text books assume banks want to lend as much as they are legally allowed, which isn't the case right now. But I digress.
The securitization market makes this all much more complicated. The supply of loanable funds isn't just a function of cash in the banking system, but also cash invested in the shadow banking system. Right now net new issuance in ABS (meaning new issuance less principal being returned in old issues) is negative, meaning supply of funds from the shadow banking system is contracting.
Consumers are like a Monopoly player who has mortgaged all his properties. Passing GO doesn't cause him to buy more houses, it causes him to unmortgage his properties! That isn't inflation!
Getting back to consumers, it isn't clear to me that consumers are actually running out of money. Check this chart of the Household Financial Obligation Ratio, basically a debt service coverage ratio for consumers.
So consumers might not have to repay debt all at once, which is nice. It means a second-half recovery of sorts remains in play. But the large losses in assets coupled with out-sized debt ratios are going to cause consumers to keep saving at an elevated level. Check out liabilities as a percentage of disposable income.
This isn't a perfect ratio, since liabilities is a stock and income is a flow. But with declining asset values (both homes and financial assets), means that consumers are actually going to have to rely on incomes to pay debt service. Or for that matter to qualify for loans. So I'd think this ratio moves back toward 100%. That implies $3.6 trillion. TRILLION. It will be repaid over time to be sure, but it will remain a continual drag on consumer spending levels.
So keep this in mind when you think about the size of Fed/Treasury programs. $3.6 trillion. Are we worried about $800 billion for the "Stimulus Package" or the $1 trillion revised TALF? Not in terms of inflation.
I'm looking forward to the day when I'm worried about inflation. It isn't today.
23 comments:
I'm not sure I agree with the household debt to disposable income ratio as a useful metric.
If one makes $50,000, using the 28% rule (we'll ignore credit card debt--though that would make the following analysis more severe), they can afford a mortgage that's roughly $200,000 (after taxes and insurance). That's a 400% ratio on gross income, probably 600% or more on disposable income.
Only 60% of people own houses, and most aren't at the start of their 30-year amortization, but I can't see any reason why we'd expect the ratio to be around 100%, nor is it necessarily unhealthy to be at 200-300% as an individual. To further that analogy, as an individual, at 100% it implies you could pay off all of your debt in one year with your disposable income--at that level, nobody would ever buy a house. As you point out, you're comparing an asset to cashflow.
Your earlier chart is much more interesting--financial obligations to disposable income. If that's graphed with a zero on the y-axis (Haven't you read Tufte?!), I'm surprised at how little it's gone up. Certainly there's a wealth effect to losing value in one's house, but people's budgets are hardly under pressure if they're employed (thanks in no small part to our absurdly low short-term rates).
Just some nits--keep up the great work.
As an aside, the dollar index is looking very oversold now.
Also, gold failed to perk up when the Fed let treasuries slide pass 3% on the 10 year and 4% on the longer dated paper.
Remy:
I think the chart is useful if taken in context of the fact that assets have declined, such that debt may also be higher than assets. Plus if you assume interest rates eventually rise, the level looks untenable.
As I say, $3.6 trillion isn't a magic number, but can't we agree the number is much higher than the $800 billion stimulus?
Also Home prices... when in history have we seen inflation when home prices have been falling drastically.
Inflation means that people are bidding up the price of goods. Too much money chasing too few goods. Does that really seem likely any time soon? I agree with you AI.
Yeah, inflation is not a risk for the short or intermediate term, likely as long as unemployment remains high.
What is happening are competitive currency devaluations (evidenced recently by the IMF selling gold), industrial countries trying to get an advantage over other industrial countries, by having weaker currencies so as to make their exports sell better and create/keep jobs. These countries are in effect trying desperately to export their own deflation to other countries. The greatest risk globally is an all-out deflationary economic collapse.
...Joseph
Guess it's time for another goose the mkt game by the Feds.
Wed is 10-yr auction and Thurs is 30-yr auction. This is about getting low yields for Treasuries. BAC rumors are just the catalyst.
Treasury selling a boatload of long-bonds? The equity market can crash to raise T-Bond prices and lower yields.
By Friday, it's anyones game again.
What's the source for the "net issuance of ABS" data? (Thanks!)
SIFMA publishes both issuance and total outstanding, which tells you what the "net" issuance has been.
www.sifma.org
I don't understand how the Fed's new policy of paying interest on reserves equates to printing money. Far more is removed from the system by banks parking cash at the Fed than is paid out by the Fed in interest. I assume I'm missing something.
(1) The banks vs. the (2) non-banks (or financial intermediaries, or the shadow banking system). the non-banks are the customers of the member banks.
Loans made by the non-banks involve a turnover of existing money, or the transactions velocity of money.
loans by the member banks involve an increase in both the volume and the rate of turnover of new money
You have it right, matching savers with investments is an important part of GDP.
And as you said, all this isn't captured via the money aggregates.
historically, the non-banks have had a more significant impact on the economy than the member banks (thru deleveraging, or dis-intermediation, or their shrinkage or their growth).
another point: contrary to economic text books (and virtually all economists), the monetary base is not a base for the expansion of money & credit...legal reserves are that base...
an increase in currency held by the non-bank public (the largest part of the monetary base) is literally deflationary if not offset by reserve bank credit.
and because of the interest on reserves regime, you must track required reserves (note also that because the Board of Governors publishes required reserves you must assemble the figures by adding componets of the St. Louis FED's),
today, excess reserves (like in the Great Depression), are idle and un-used. we paid $88b in 2008 to the member banks for parking their deposits with their Districk bank.
in the current regime, excess reserves act to restrict the expansion of the money supply, or offset the expansion of the asset side of the FED's balance sheet.
Al,
I think your analysis is partly correct. The danger of an inflationary spike in the near term (within the next 12 months) is relatively low. Even in the most optimistic scenarios we will still be recovering from a nasty recession. The velocity of money is unlikely to increase appreciably in that time frame. It is in the intermediate and longer term that the effects of inflation will begin to be felt.
Here I think its worth while to clarify some definitions. Rising prices is not inflation. It is a symptom of inflation. Inflation occurs with the printing of money and the debasing of the currency. The effects of inflation are often delayed, sometimes by years. But the inflation of the dollar has already occurred.
The main reason we are not feeling its effects yet is because of the low velocity in the money supply, not its size. A lot of the cash that is out there is sitting in banks who are afraid to let it out. When eventually the banks do start lending again then hang onto your wallet.
I have read a lot of interesting arguments from people trying to explain why this time is different and we can mass print money while running up stratospheric deficits without feeling the effects of a debased currency that few people will want.
As I noted in a post on another thread, the issue is whether or not the causes for the decline in the dollar which we saw over most of this decade have been removed or simply paused by a combination of temporary circumstances related to the economic crisis and panic of 2008-09. I have seen no reason to believe that the current strength in the dollar is anything other than a temporary anomaly.
I don't think we should be pushing the panic button, yet. At some point in the future we will feel the effects and consequences of the fiscal and monetary insanity that has gripped Washington for eight years and appears to be continuing under the current administration at an even more reckless pace. The time for forward thinking persons to put their ducks in a row is now.
John
Disclosures:
Long on PRPFX, AEM, GLD and a diverse selection of high grade non-USD denominated foreign bonds.
Inflation is primarily a monetary phenomenon: an excessive flow of money relative to the volume of financial transactions consummated, and the volume of goods and serves offered in the market place.
Inflation represents a chronic "across-the-board" increase in prices, or, looking at the other side of the coin, depreciation in money.
It is a truism that if the flow of money in the market place increases relative to the flow of goods and services offered for sale, prices on the average will rise.
Only price increases generated by demand, irrespective of changes in supply, provide evidence of inflation. There must be an increase in aggregate demand which can come about only as a consequence of an increase in the volume and/or transactions velocity of money. The volume of money flows must expand sufficiently to push prices up, irrespective of the volume of financial transactions and the flow of goods and services into the market economy.
The "equation of exchange" P=MV/T embodies the truistic relationship between money flows and the aggregate value of all monetary transactions. P represents the unit prices of all transactions; T, the number of "units" of all transactions; M, the volume of means-of-payment money; V, the transactions rate of money flows; and MV, the volume of monetary flows.
While the usefulness of the equation is somewhat diminished by the impossiblity of quantifying P and T, the validity of the equation is not. Obviously, if the FED allows the banking system to increase the money supply, ceteris paribus, (no change in V or T) prices will rise, etc.
Milton Friedman "described the “long and variable lags” between policy actions and their consequences". However, the only long and variable lag is the one of ignorance and arrogance.
Monetary lags are always exactly the same length. It is therefore accurate to say that it is impossible to miss an economic forecast (one of an intermediate term).
The rates-of-change in legal reserves (the proxy for real-gdp) show upward growth for the entire year.
I can only say that the rates-of-change in legal reserves (the proxy for inflation) have turned up.
A lot of the cash that is out there is sitting in banks who are afraid to let it out. When eventually the banks do start lending again then hang onto your wallet.<<<<<<
That's not the big part of the problem. Banks would love to lend, especially with the favorable yield curve. The problem is people and businesses either don't want to borrow or don't have enough collateral or earning power to meet credit standards.
It's called UNEMPLOYMENT, which shuts off the spigots both for people and corporations.
That is why it is the government which MUST open its spigots, or else UNEMPLOYMENT would continue to spiral higher. Government measurements understate unemployment, and I have seen real numbers close to 20%, if one includes the underemployed (Those working part-time but want to work full time) and those who have given up trying to look for work.
Plus, one other, rather new, factor which keeps inflation under control is the really global economy, basically international competition to produce stuff cheaply. Nothing like this existed to such an extent during the 1930's.
As for eventual inflation in the long term, yes that is a risk, however it appears clear that the government will raise taxes enough (close loopholes, too) to begin paying down the debt, plus, what the markets are also factoring in is a restructuring of our economy (investing in education and healthcare to produce a better educated and healthier workforce). Plus, aiming to change our energy dynamics which will end up creating less demand for oil, hence less importing of it, plus exporting new energy technology, etc. Plus, getting people working, so there are more tax revenues.
Sure, some unplanned catastrophe could happen, geopolitical, etc to mess things up worse, but for now financial markets are basically factoring in the stuff I mentioned above and like what they see, so far.
Again, it is UNEMPLOYMENT which is the key. To get caught up with all kinds of fancy monetary mumbo-jumbo of terms may sound intelligent, but it misses the main point which drives it all.
....Joseph
Please note that the FED stopped publishing the “T” in Irving Fischer’s equation when the economist (Ed Fry) that administered the statistical release retired. Also, the G.6 release was subject to periodic reviews to determine its usefulness relative to its cost. No subscribers were surveyed to determine its importance in the Board of Governors “test”.
So my projections use only half the equation.
mixed that up, should have been Vt (demand deposit turnover, bank debits, transactions velocity)
the Fed has never been very cooperative in supplying comparable data. first it's non-seasonally adjusted, then only seasonally adjusted, then spliced & chained, etc.
as long as the trend relationship between transaction accounts and non-transaction accounts stays relatively constant then the rates-of-change in required reserves works
Ok I was wrong about the equities/bond movements.
This mkt is getting very hard to call. In retrospect it wasnt a good call going into the stress tests but now that this hyped event is over, maybe the Obama ppl will let the mkt makers take us back down to reality.
The "This time is Different" is kind of the Godwin's Law of financial forums isn't it?
Nothing is different this time. All the same equations hold. In fact, that's why I was comfortable using a two-year old analogy for describing inflation. The problem is that looking merely at Fed activity in printing money isn't the whole equation. For many years, velocity was minor part of the equation. Thus printing money would cause massive inflation. Now velocity has fallen off a cliff.
The question is: when velocity comes back, which it will, can the Fed control inflation at that point? That's an unknown question, but its also a question that's at least a year, maybe 3-4 years off.
another maxim: ignore the seasonally mal-adjusted data, e.g.,
(1) Some people think Feb 27, 2007 started across the ocean.
"On Feb. 28, Bernanke told the House Budget Committee he could see no single factor that caused the market's pullback a day earlier".
In fact, it was home grown (Bernanke was directly responsible).
Feb 27 coincided with the sharpest decline in 1) the absolute level of “free” legal reserves, & 2) & an historically large peak-to-trough reversal of roc’s for proxies on real GDP & the deflator. Bank squaring day also factored in. It was an unprecedented move in terms of volume and duration.
(2) “Black Monday" Oct. 19, 1987, coincided with the sharpest and fastest peak-to-trough decline in the roc for real GDP since 1917. It was the trigger (bank squaring day again) but there were many other factors as well.
Ought to be able to figure the transactions velocity of money by calculating the "expansion coefficient". The "money multiplier" fell and has turned a little.
There are different ways to crunch the numbers but I like bank credit divided by legal reserves.
Legal reserves have recently been growing at the fastest clip calculated.
Both the absolute figure and the rates-of-change are exploding from the abyss in March to a surfeit in May.
So, don't expect the continuation of bad news we've had in the first quarter 09.
Bernanke is doing an exceptional job guiding the Federal Reserve.
2000 jan -0.08 0.01 top
feb -0.06 -0.04
mar -0.13 -0.12
apr -0.13 -0.04
may -0.07 0
jun -0.12 -0.06
jul -0.1 -0.05
aug -0.11 -0.03
sep -0.11 -0.04
oct -0.12 -0.07
nov -0.12 -0.11
dec -0.14 -0.09
2001 jan -0.14 0
feb -0.14 -0.04
mar -0.13 -0.11
apr -0.12 -0.02
may -0.12 -0.01
jun -0.1 -0.04
jul -0.07 0
aug -0.06 0.02
sep -0.05 0.03
oct 0.11 0.18
nov -0.02 0.01
dec -0.02 0.04
2002 jan -0.01 0.16
feb 0 0.1
mar 0.01 0.01
apr 0.01 0.07
may -0.04 0.03
jun -0.03 -0.03
jul -0.02 -0.02
aug -0.01 -0.13
sep -0.02 -0.04
oct -0.02 -0.06 bottom
nov -0.01 -0.11
dec 0.02 -0.07
2003 jan 0.07 0.06
feb 0.05 0.01
mar 0.07 0
apr 0.06 0.06
may 0.05 0.06
jun 0.08 0.05
jul 0.1 0.12
aug 0.1 0.14
sep 0.11 0.15
oct -0.05 0.09
nov 0.06 0
dec 0.05 0.03
2004 jan 0.04 0.13
feb 0.04 0.08
mar 0.09 0.05
apr 0.11 0.1
may 0.14 0.07
jun 0.17 0.03
jul 0.18 0.04
aug 0.15 0.06
sep 0.19 0.08
oct 0.18 0.06
nov 0.16 -0.01
dec 0.17 0.04
2005 jan 0.18 0.15
feb 0.13 0.03
mar 0.13 -0.01
apr 0.13 0.03
may 0.12 0
jun 0.11 0.01
jul 0.07 0
aug 0.02 -0.01
sep 0.01 0
oct 0.01 -0.05
nov 0.02 -0.14
dec 0.04 -0.05
2006 jan 0.04 0.03
feb 0.01 -0.04
mar -0.02 -0.08 top
apr -0.03 -0.03
may -0.02 -0.02
jun -0.01 0
jul -0.03 0
aug -0.06 -0.02
sep -0.08 -0.03
oct -0.08 -0.06
nov -0.06 -0.11
dec -0.07 -0.04
2007 jan -0.11 0.05
feb -0.09 -0.04
mar -0.11 -0.1 bottom
apr -0.09 -0.05
may -0.05 -0.01
jun -0.05 0.02
jul -0.08 0.01
aug -0.07 0
sep -0.07 0 top
oct -0.04 -0.03
nov -0.04 -0.06
dec -0.04 0
2008 jan -0.07 0.08
feb -0.05 0
mar -0.04 -0.07
apr -0.03 -0.01
may -0.01 0.05
jun -0.04 0.04
jul -0.03 0.04
aug 0.02 0.05
sep 0.04 0.05
oct 0.17 0.14
nov 0.24 0.19
dec 0.3 0.31
2009 jan 0.45 0.57
feb 0.4 0.39
mar 0.38 0.25
apr 0.4 0.38
may 0.47 0.49
jun 0.47 0.47
jul 0.51 0.46
aug 0.55 0.32
sep 0.53 0.23
oct 0.54 0.15
nov 0.54 -0.01
dec 0.51 0.07
2010 jan 0.46 0.15
feb 0.51 0.08
mar 0.56 -0.01
Left column represents real-growth. Right column represents inflation. Caution, the expansion coefficient and or the distribution of deposit classifications will alter the comparison.
Also, remember that legal reserves are no longer binding or that legal reserves no longer represent a weighted arithmetic average that is relatively constant.
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