Brad DeLong's Semi-Daily Journal: A Weblog

The recent increases in the Federal Funds rate coupled with a decrease in long term interest rates is highly unusual at the beginning of a Federal Reserve tightening cycle. After a 10 month series of Federal Funds rate increases in 1994, it was apparent the economy was slowing and long term interest rates began to decline several months before the Fed finished the cycle.

Bond investors now appear convinced there is no inflation to worry about and the economy is still weaker than the Fed has indicated. Employment prospects simply do not appear promising. There seems little reason then for the Fed to continue to raise short term rates. I think the Fed will raise, but I would much prefer a halt and hope growth will begin to increase enough to generate better than 150,000 jobs a month.

For reasons I've posted here in earlier threads, I've got to admit I don't see what the basis will be of a supposedly strengthening US economy. I don't know if we'll have a double-dip recession by the traditional GDP definition (possible but still not yet the way to bet, IMHO), but I'm expecting something that will look like it from an employment standpoint.

Long-term interest rates are falling, in reaction to the diminishing probability that John Kerry will win the White House.

Kerry has been promoting a typical smorgasbord of far Left liberal spending, together with the well-nigh nationalization of the Health Care sector. At the same time, he has locked himself into full support for traditional Medicare and Social Security, ruling out entitlement reforms.

His only plans to pay for it all are distinctly *partisan* platforms of extreme tax increases that would never past a Republican -- or even a *Democrat* Congress with reasonable representation of moderates.

Kerry has also committed to reneging on most of the Free Trade policies of the past 60 years, drunk by the siren song of "fair trade" (belying his demagoguery about "multilateralism").

Therefore, it's been clear to market makers that a Kerry victory would mean significantly worsening deficits, beyond (as a % of GNP) the deficits even of the 1980s which were higher than today's. Probability discounted expectations moved in Kerry's direction for a period following his nomination, raising long-term interest rates, slowing growth and diminishing economic prospects -- the wages of Democrat flirtation with the most Liberal senator of modern times..

Now comfortable with the likelihood of a Bush victory, market makers have moved interest rates back into line with their expectations under a second Bush Administration of a stronger economy, a halving or better of the deficit over the next 4 years, and an ever strengthening posture for U.S. participation in international trade and investment.

Brad, that's the whole point!

BushCo has so successfully debilitated the US economy with unredeemable deficits, and handed over so much of the liquidity float to investors with other global investment alternatives, that Greenspan's living under a Sword of Damocles, now so badly frightened that he dare not move interest rates, relying on Japan and retirement bond funds frantic for currency equilibrium and liveable ROI.

Most seniors are so petrified of a precipitous stock crash in the face of IBM's pension fiasco legal precedent, they only buy US Treasuries, even though they've been downgraded to "junk".

Strange, the papers are full of unfilled low paying jobs, mortgage rates are dropping again, DJIA/NASD is holding stable at 10K/18C, and yet folks are dumping their second cars and retail is dropping -5% per month, as they focus on the bare essentials of rent, utilities and groceries in the face of take-home pay now at the lowest percentage of GDP since the Great Depression, and a precipitous decline in the value of US$.

Can we call this "double-dip" recession what it really is? Isn't it an Argentinian Meltdown?

So here's my question to you. When the US$ does devalue overnight, and US Treasuries rates spike to 8% in the face of weak sales, and the deficit is declared permanent, and SS is robbed to pay for Iraq as the military draft is re-instated, what international currency should we purchase?

I think South African kruggerands....

Stable Dictum: Easily the most comically foolish comment even for a troll.

Harry Possue: As absurd as Stable. Duh.

I commented on another Blog this week my estimate We are entering into a Consumer Spending flux where Consumers are trying to pay down their current level of Consumer and Household debt. Greenspan has to raise Interest rates as scheduled, in order to hold the value of the Dollar against other Currencies. Some Economists have stated We should devalue now, which will improve U.S. trading position. This is very risky, though, because of the total amount of Treasuries held by foreign governments and Corporate structure; recognize what Greenspan is belately recognizing, the Inflation has been developing Overseas through the sale of U.S. Treasuries.

The Inflatiion will be re-imported to the domestic market with foreign government sale of these Treasuries upon the open market. We will then recognize We have been enduring double-digit Inflation ever since the first Bush Tax Cut. lgl

http://www.nytimes.com/2004/09/18/business/18trade.html?pagewanted=all&position=

U.S. and Trade Partners Maintain Unhealthy Long-Term Relationship
By LOUIS UCHITELLE

No organization has been more alarmed about America's constantly rising deficit in global transactions than the Institute for International Economics, a center of expertise in this field. A disaster in the making, declares the institute's director, C. Fred Bergsten - and one coming soon.

But month after month, indeed year after year, the disaster has failed to occur and now one of the institute's own trade experts, Catherine L. Mann, has stopped, as she puts it, crying wolf.

"Because nothing happened, I did a lot more analysis," Ms. Mann said, "and I have come to the conclusion that a co-dependent relationship exists between the United States and its trading partners.'' That situation "may not be healthy for either side,'' she added, but it "can last for quite some time."

For Americans, the positive side of this equation - known as the balance on current account - is that they get to consume much more in goods and services than they produce. As for America's trading partners, particularly China, Japan and the Asian tigers, they gain from an overseas marketplace that allows them to expand production and job creation beyond what their own population can consume.

The downside for the United States is that most of its imports are purchased on credit extended by its trading partners. The overall indebtedness is now about $4.4 trillion, nearly twice what it was in 2000 - an increasingly costly arrangement for Americans and a potentially risky one for the nation's foreign creditors.

While Mr. Bergsten, one of the better-known commentators on the global economy, remains alarmed that the arrangement could unravel abruptly, with the dollar plummeting in value and inflation rising, Ms. Mann represents an alternative view held by a growing number of economists. This group argues that rather than crisis, the United States is caught in a gradual, almost imperceptible deterioration brought on by the yawning deficit in trade and other international transactions, and the deterioration could continue for a long time.

"If there has been no crisis, there has to be a counterweight that keeps the crisis from happening," Ms. Mann said. "The counterweight is that the United States and its main trading partners have a vested interest in the status quo.''

No one knows how this situation will unwind. The willingness of the United States to accumulate more and more debt could indeed end painfully or it could play out gradually and mildly as the nation's trading partners pull back on their lending and Americans slow their consumption of imported goods and services.

"I think in the long term what is happening is unsustainable but it is very hard to predict a turning point in an unsustainable situation," said Robert Blecker, an economist at American University who, like Ms. Mann, describes himself as a former Chicken Little. "You can see why something cannot keep going,'' he said, "but you can also see why it keeps going."

Stephen Roach is torn in two?

"A failure to do so and keep the policy rate at 1% in nominal terms and “zero” in real terms is a recipe for a never-ending outbreak of asset bubbles. Early warning signs of such bubbles are now increasingly evident (see my 5 March dispatch, “A Time for Courage”). Largely for that reason, I have urged the Fed to raise the federal funds rate immediately to 3% (see “An Open Letter to Alan Greenspan” published in the March 1 edition of Newsweek International)."

You don't have to be a rocket scientist to listen to Zbigney or Roach and realize, JHC, these poor guys have no idea how to save US.
(As long as they receive their speaking fees)

Mann's very prescient observation mirrors that of Wolfram's in "A New Kind of Science". Chaos theory should be mandatory in economics class.

The key at this point is to watch for triggers, and examine the wildest possible flashbacks. Otherwise we are all just Rum-Dum's in a global financial arena, thinking we'll get out of this on the cheap, without any endgame strategizing.

China is the gray monkey on our backs, sucking up strategic commodity surpluses, siphoning off US$'s for black plastic wampum, and investing in AU real estate and minerals, while firmly tieing themselves to the US$ and holding total control over their *martial* domestic economic policy.

Poor Japan, tied at the hip to US in SOTA trade goods, but stuck with a fluctuating currency. Their economic model is so last year.

There has never been an economic theory for this menage de trois, and nobody seems in any hurry to develop one, preferring Friedman and Keynes.

"Someone will set the spark off,
and we will all be blown away...." (Harnick)

Ari.

We're not talking here about rational expectations driving the economy. You can make a shrill Leftist argument that rational expectations are bunk and find one or two Nobel prize winners to back you up.

But the idea that rational expectations don't drive the *bond market* is pure hokum.

Hopefully, the brief flirtation of moderates with Kerry is dead and buried, and the bond market can get on with rationally responding to the Bush agenda with lower long-term interest rates.

Be gone Stable troll, I be shrill with frauds.

"Someone will set the spark off,
and we will all be blown away...." (Harnick)

Al Queda? North Korea? They have nothing to lose in becoming spoilers of the world game of global capitlism. Either one of these groups could initiate a world depression through anthraxing Wall Street or firing off black market nukes.

I think many of theories and models are based on basically good global health of its citizens--healthy people make good consumers...sick and scared people don't spend. SARS has shown that public health is our first line of defense...global business depends upon global public health.

Furthermore, over-populated countries could be led into mass starvations due to dependence on artificial agricultral life support...

It's very likely that a cascade of events that could disintegrate the world-system has already taken place...the noise that draws a system toward a new attractor could quite possibly be Iraq; the former contraints of the old world-system have been replaced—indeed, the center cannot hold!

The center is holding nicely. Duh.

For some reason, I went and checked the bond markets in the Times yesterday for the first time in ages and was really surprised. Not that I know anything. But adding together what I've been told over the years about bond markets, my conclusion was that no one likes the amount of debt we're in, individually or collectively; that few outside of the US feel great confidence in our financial future; that our political situation stinks to the extent that it's making everyone feel a little desperate. That and the theory floating around that we're headed into a double-dip. The Bush Depression is about to become much more than just a psychological phenomenon world-wide.

PS: I don't think anyone could possibly be correct that the prospect of a Kerry victory would worsen deficits. One only has to look at recent history to realize that, contrary to CW, it's the Dems who've become the fiscal conservatives in this country. I think that if there were some optimism about a Kerry victory, the markets would reflect it. If he manages to get elected, I betcha we'll see an improvement in the markets right quick.

Are Ari's comments alway as intellectually empty as they are pithy?

Next, Ari will be telling us that the Bond markets are more afraid of Bush's tax cuts than the structural deficits of Social Security and Medicare -- the key fiscal legacy of 45 years of Democrat control of Congress! What a lark.

Bush's bipartisan tax cuts haven't even reversed Clinton's partisan tax increases. (re: use of "partisan" -- Bush's had significant Democrat support; Clinton's didn't garner a single Republican vote -sd).

In fact, it was Clinton who pursued a "corporatist" government fiscal policy -- raising taxes significantly on ordinary Americans, leaving the Fed no alternative but massive infusions of cheap money into corporate investment, to keep the economy from diving into recession.

Of course, it was cheap money and Clinton's extraordinary malfeasance on corporate governance issues that lead to broad asset bubbles and the Internet IPO debacle, and wiped out trillions of dollars in pensions funds and private savings.

Bush's initial tax cuts were too little, too late. Clinton had refused to consider working with the Republican Congress to reformulate tax policy in the late 1990s, when it might have had more impact, leading to the Clinton/Gore Crash of 2000 and plunging the U.S. economy into recession.

It took a second round of tax cuts for Bush to right-size incentives to work, save and invest.

With the legacy of Bill Clinton's exceedingly damaging economic policies and 9/11, the U.S. economy has face extraordinary challenges over the past 4 years. Thank goodness that President Bush engineered a relatively speedy turnaround from the Clinton Crash of 2000, at a time of War. By any meaningful measure of comparison, say 1929, Bush's accomplishment has been nearly miraculous.

As the only candidate willing to take on the Medicare and Social Security deficits with real reforms and privatization, and committed to capping the growth of the government sector going forward, the (finally!) seemingly unbeatable, Bush is putting financial markets at ease, bringing long-term interest rates to reasonable levels.

stable dictum -- better look at a few facts, for example when you add up Bushs promised expenditures they are much larger than anything Kerry has promised.

We now have a system where the Republicans believe in a big, insolvent government and the Democrats believe in big, solvent government.

How long until the democrats say thank you Reagan and Cheney for showing us that deficits do not matter, we can now out bid the Rebuplicans in buying votes from people with their own money.

The bond market may be starting to discount the conclusion that another Bush term will lead to depression -- nothing else he has ever tried has succeeded and Daddy's friends can no longer bail him out..

Could it be possible that economic growth may continue pretty much the way it is now? We are growing reasonably well, just not fast enough to create enough domestic demand to significantly add to job creation. We might continue in this way for quite a while. About 150,000 jobs created a month, enough to meet job creation needs due to labor force growth. Fairly low long term interest rates, reflecting little inflation and moderate economic growth. A stable housing market, stable dollar, moderate growth in the stock market. The most important problem in the near term may be the persistence of high energy costs and a crimping of household budgets to meet these costs.

Stable Dictum gives the standard fare analogy that nothing in the Clinton administrations was responsible for any economic gains, and that Republican farsightedness brings Wealth and prosperity. Why do all Republican administrations since Herbert Hoover--yes, even Eisenhower, hold recessive conditions within about a year of Inaugeration? Why do all Republican administrations since Reagan preside over falling Labor Incomes? Why do Economic studies show that Stock and Bond Markets have shown better performance under Democratic administrations since FDR? Why are Republican administrations actually responsible for more National Debt than any supposed liberal Democratic administrations--remember it was a Democratic President Kennedy that first proposed raising the Debt ceiling to $100b, and the Republicans screamed? Democratic Liberal programs, when examined, have incited about one trillion of the current Debt, and Clinton ran Surpluses. It is ridiculous that Republicans even attempt to claim they are fiscal conservatives. lgl

anne

"stable housing market" Really??

I am sorry but I think economy is resting on a House of Cards based on inflated real estate. The Housing Bubble will burst as soon as interests rates rise. Certainly the refinancing and the Home equity loans keeping a lot of folks head above water will give way. I know alot a people say that since most people went fixed that there is not any exposure. But in fact there are plenty of homeowners who had to take out Adustable Rate or even no Principle payback mortgages loans just to get into the housing market.

I don't think Greenspan can raise interest rates without everything falling a apart.

May question for the Prof is how exposed are our Foreign Trade partners to the inflated Real Estate market and is this another one of reasons they have been so tolerant to the Fed deficit/Consumer Debt madness.

How come when I talk about a Housing Bubble, I feel that the rest of world thinks I a LaRouchie. I am I off my meds for believing those crying wolf. Or is the truest sign of a bubble about to burst is when those who have been crying wolf finally grow hoarse.

I'm beginning to realize that where you live influences your view of the economy. House of cards describes what we're seeing here in the southern plains, and I say that in spite of the fact that I live in a very prosperous community. But it's an anomaly, unfortunately, burgeoning thanks to the investments of people with money in attractive retirement and second home real estate. "Normalization" of interest rates will curb that and, of course, kill the hopes of the less fortunate who are children of this community and who won't be able to find housing.

Politics aside - would someone knowledgeable in the field add the inheritance figures to the process. It's been my experience that a lot of housing is coming into the market from death and retirement - how long will the economy absorb this influx before it starts to depress values to the true price rather than the current inflated level.

anne

Read This.
http://www.washingtonmonthly.com/features/2004/0404.wallace-wells.html
or this
http://www.businessweek.com/magazine/content/04_29/b3892064_mz011.htm

Is A Housing Bubble About To Burst?
As rising rates send mortgage payments higher, demand may cool

How crazy is real estate getting in parts of the country? Ask Sierra and Corbin Stewart, who just bought a modest, 2,000-square-foot house in Pleasanton, Calif., for $730,000. Mortgage and tax payments will consume 55% of their income, forcing them to do without extras such as cable TV. Says Sierra, a 29-year-old marketer: "The other night we were doing our budget, and we almost called the real estate agent and said we want to get out."

It may not be long before the Stewarts -- and other recent home buyers paying exorbitant sums around the country -- wish they had paid attention to their cold feet. After an amazing four-year boom in residential real estate, the housing market could finally be topping out and heading for a downturn. The culprit: rising interest rates. House prices could flatten on a national level in the next year or so while taking a spill in overheated coastal markets. A downturn in housing would squeeze recent buyers who overleveraged themselves to pay top prices -- and risk slowing the entire economy by cooling consumer spending as well as housing construction, lending, and the real estate business.

It's always tricky to call the top of an overheated market, and the pessimists have been wrong before. Optimists argue that even if there is a correction, most homes will remain far more valuable than they were a few years ago. And they say immigration, second-home purchases, and boomers' inheritances will support housing. Says Angelo R. Mozilo, chairman and CEO of mortgage lender Countrywide Financial Corp. (CFC ): "I think [the market] will continue to rise."

MONTHLY PAYMENT JUMP
But this time something important is different: Interest rates are inching up. It was the Federal Reserve-engineered decline in rates that inflated the housing bubble. But starting with a quarter-point increase in the funds rate on June 30, the Fed has begun what promises to be a prolonged tightening cycle. Even if the Fed's hikes are measured, higher mortgage rates will inevitably make houses less affordable. If 30-year fixed-rate mortgages rise just one percentage point, to 7.2% from their current 6.2% -- well within the range of forecasts -- house prices would have to fall 11% to keep new buyers' monthly mortgage payments from rising. If fixed rates went to 8%, prices would need to fall 20% to keep payments level.

Rising rates will hurt more than in the past because the market is more dependent on heavily leveraged buyers. Mortgage debt has shot up even faster than home values since 2000, leaving homeowners' equity at just 55% of housing value, down from 72% in 1986, according to Federal Reserve data. Leverage intensifies the pain of falling prices. If, say, a buyer owes $450,000 on a house that's valued at $500,000 and the house's price falls 10%, the equity shrinks to zero.

Heavy mortgage borrowing since 2000 has enabled the housing market to dodge an iron law: House prices can't perpetually rise faster than incomes. For the past four years, they have. The ratio of house prices to median family income is a record 3.4, a figure that's 19% above the 1975-2000 average, according to data from the Office of Federal Housing Enterprise Oversight and the Census Bureau. As rates rise, a return to the long-term-average ratio would require housing prices to fall 19% -- or incomes to shoot up an implausible 24%.

A downturn in housing, if it comes, is likely to chill the economy. People will feel less wealthy, hence more reluctant to spend. Goldman, Sachs & Co. (GS ) economist Jan Hatzius, among others, argues that a decline in housing wealth dampens consumer spending at least twice as much as a same-sized loss in the stock market. Even homeowners who still feel like spending would have a harder time qualifying for home-equity loans or cash-out refinancings -- a major source of consumer liquidity for the past few years.

Rather than a sudden wallop, the economic impact would be gradual and grinding. Ian Morris, U.S. economist at HSBC Securities Inc. (HBC ), estimates that housing prices nationally will slide 5% to 10% over the next five years. That could cause economic growth to slow to 2% by the second half of 2005 from 4% now, he predicts in a report called The U.S. Housing Bubble.

Optimists on housing point to the National Association of Realtors' Housing Affordability Index, which shows that a median-priced existing house at $184,000 is easily affordable by a family with the median income of $55,000. But that's only because interest rates are so low, holding down monthly payments. The juice of cheap mortgages has made housing pricey by every other measure. They're high not only in comparison with family incomes but in relation to rental rates for similar properties and relative to the cost of new construction.

Federal Reserve Chairman Alan Greenspan has downplayed the danger of a national housing bubble, arguing in part that housing is a local market. Sure enough, prices are still reasonable in most of the Heartland, from Ohio to Texas to Arizona, because construction has kept pace with demand. But bubbles are appearing in enough markets that their impact, if they were to pop, would be felt nationally. Greenspan also asserts that the high cost of buying and selling houses dampens speculation. Nevertheless, some markets are seeing speculative behavior such as "flipping," in which people buy houses or condos before they're even built and then sell them for a profit a few months later.

The overheating is greatest in markets such as Los Angeles, San Francisco, San Diego, Washington, New York, and Boston. The takeoff in coastal real estate started around 2000 -- suggesting that the speculative fever of the late 1990s did not die but instead jumped from stocks to real estate. From 2000 through the first quarter of 2004, single-family home prices are up at an annual rate of 8.2% in the Pacific region, 8% in New England, and 7% in the Middle Atlantic region, according to the Office of Federal Housing Enterprise Oversight. Prices rose 18% in Los Angeles, 14% in Miami, and 13% in Washington in the year through the first quarter, says the agency.

The most troublesome aspect of the price runup is that many recent buyers are squeezing into houses that they can barely afford by taking advantage of the lower rates available from adjustable-rate mortgages. That leaves them fully exposed to rising rates. In fact, the rise in one-year adjustable rates since late March has already raised annual borrowing costs for new buyers by 25%. And data from the Federal Housing Finance Board show that the most expensive markets tend to have the highest share of buyers with adjustable-rate mortgages.

Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken. Caveat emptor

anne,

What I thing is really bad is that the vast bulk of the Housing Bubble is located in Blue State America. The same previously "High Income" Metropolitan Americans who have been hit by Corporate Outsourcing, Vote Democratic, and for whom Bush could not give a dam since he intends his Tax Cut afloat with Alternative Minimum Tax. I am sorry but this a Perfect Storm crisis in the making.

Just Call ME Lyndon

Thank you! Let's continue with the argument from a worrisome perspective:

http://www.cepr.net/publications/debt_trends.htm

Mortgage debt is mostly fixed rate, although a large and rising percentage of mortgage debt is in the form of variable rate mortgages. Even fixed rate mortgage debt turns over relatively quickly. Approximately 9.0 percent of existing homes are sold every year, which means that after five years close to 40 percent of homes will have been sold (assuming some homes are sold twice)3. If mortgage interest rates rise by an average of 1.5 percentage points on 40 percent of existing mortgage debt, this would also raise the financial obligations ratio by approximately 0.5 percentage points. In short, the virtually inevitable increase in interest rates will push debt service obligations to new records, even if households stopped increasing their debt-to-income ratios.

But the impact of rising debt burdens is likely to be more important in raising the financial obligations ratio than higher interest rates. If the ratio of household debt to disposable income actually rises by 44 percentage points by 2009, as it would on its current path, this would raise the financial obligations ratio by almost 3.0 full percentage points, even with a 6.0 percent interest rate. Obviously, the impact of a rising debt burden will be even greater if it is accompanied by a further rise interest rates.

Of course any substantial rise in mortgage interest rates is virtually certain to crash the housing bubble, which has been the basis of much recent borrowing. This housing bubble has led to an unprecedented run-up in home prices. Over the post-World War II era, home prices had largely risen in step with the overall rate of inflation. Only in the past nine years have homes prices substantially outpaced the general rate of inflation (Baker, 2004). The argument that this run-up can be explained by fundamentals - a shortage of housing relative to demand - is easily refuted by the fact that there has been no comparable run-up in rental prices. The rise in rental prices has only slightly exceeded the overall rate of inflation over this period, and in the last year and a half, rents have actually fallen behind the overall rate of inflation.

Figure 2 shows the path of real family income and real home sale prices. As can be seen, from 1953 until 1995 home prices moved almost exactly in step with the overall rate of inflation. Real median family income is included to correct a common misperception that home prices rise in step with family income. While it is reasonable to expect that if a family's income rises by 20 percent then it will spend approximately 20 percent more on housing, it is not reasonable to expect that it will spend 20 percent more on the same house. The indexes used in figure 1 are showing the real increase in the price of the same homes through time; they do not reflect price increases attributable to families buying better homes. Since 1995, house prices have increased by more than 35 percent in real terms.

Figure 2

Of course, the collapse of the housing bubble, like the collapse of the stock bubble, will pose serious problems for the economy and will almost certainly lead to another recession. Home construction will likely fall off by 40 percent or more, and the borrowing based on housing wealth will grind to a halt. While this will slow or reverse the run-up in household debt, it will not be a good period for the economy. However, as long as the bubble persists, the level of indebtedness will increase, making the inevitable adjustment ever more painful.

It is not clear why the FOMC would want to raise
interest rates.An examination of real GDP growth
ex inventories,or final sales shows a declining
growth rate since the third quarter of 2003.The
sharpest drop occurred in the second quarter bringing the GDP final sales growth rate down
to 2.8 %.Attribution of the so-called "soft
patch" to rising energy prices ignores the
fact that between 2000 and 2003 fixed investment
by non-farm nonfinancial corporations declined
by 10% while internal funds funds rose by 30%.
And according to Moodys Investor Service the
amount of cash and liquid investments for these
same corporations in the 12 months ended March
2004 equaled 146% of capital spending.Such an
excess of funds available to actual investment
is the highest since 1962.The Wall Street Journal
commenting on the Moodys report said:"The cash
hoard has grown even as companies paid down debt
and bought back stock."
With these non-financial companies having the highest cash to debt ratios in 35 years it
suggests that there is considerable uncertainty
and lots of caution out there in the corporate
sector.
Why in the world would the FOMC want to raise
rates at this time.?
Confused.

It is not clear why the FOMC would want to raise
interest rates.An examination of real GDP growth
ex inventories,or final sales shows a declining
growth rate since the third quarter of 2003.The
sharpest drop occurred in the second quarter bringing the GDP final sales growth rate down
to 2.8 %.Attribution of the so-called "soft
patch" to rising energy prices ignores the
fact that between 2000 and 2003 fixed investment
by non-farm nonfinancial corporations declined
by 10% while internal funds funds rose by 30%.
And according to Moodys Investor Service the
amount of cash and liquid investments for these
same corporations in the 12 months ended March
2004 equaled 146% of capital spending.Such an
excess of funds available to actual investment
is the highest since 1962.The Wall Street Journal
commenting on the Moodys report said:"The cash
hoard has grown even as companies paid down debt
and bought back stock."
With these non-financial companies having the highest cash to debt ratios in 35 years it
suggests that there is considerable uncertainty
and lots of caution out there in the corporate
sector.
Why in the world would the FOMC want to raise
rates at this time.?
Confused.

It is not clear why the FOMC would want to raise
interest rates.An examination of real GDP growth
ex inventories,or final sales shows a declining
growth rate since the third quarter of 2003.The
sharpest drop occurred in the second quarter bringing the GDP final sales growth rate down
to 2.8 %.Attribution of the so-called "soft
patch" to rising energy prices ignores the
fact that between 2000 and 2003 fixed investment
by non-farm nonfinancial corporations declined
by 10% while internal funds funds rose by 30%.
And according to Moodys Investor Service the
amount of cash and liquid investments for these
same corporations in the 12 months ended March
2004 equaled 146% of capital spending.Such an
excess of funds available to actual investment
is the highest since 1962.The Wall Street Journal
commenting on the Moodys report said:"The cash
hoard has grown even as companies paid down debt
and bought back stock."
With these non-financial companies having the highest cash to debt ratios in 35 years it
suggests that there is considerable uncertainty
and lots of caution out there in the corporate
sector.
Why in the world would the FOMC want to raise
rates at this time.?
Confused.

"stable dictum -- better look at a few facts, for example when you add up Bushs promised expenditures they are much larger than anything Kerry has promised."

This piece of Leftist melarcky ignores the fact that the so-called "promised expenditures" analysis of the Bush program trumpeted by the major Democrat-leaning press outlets last week considers transition costs to self-financed, sustainable and market oriented Social Security and Medicare an "expenditure".

Whereas, by proclaiming Bush $ > Kerry $ they are buying into the ludicrous notion that Kerry's promise not to reform Social Security and Medicare are "costless".

More likely, of course, it's a wink and nod acknowledgment that Kerry's promises are bunk.

I was glad to see anne's post regarding the Catherine L. Mann article. It's what I'd like to write, had I but the time. As a Japanese-fluent engineer involved in Japan-US trade, I have been watching our trade and current account deficits develop for more than 20 years now.

Because our human and physical capital base has so atrophied, if Asia ever stops distorting the exchange rates by funding our deficits, it will be hard for us to restore the ability to meet domestic demand for the goods we'll no longer be able to import, especially as so much capital equipment is now made only overseas, and will rise in price right along with the finished goods.

What Asian governments are in fact doing is to engage, on a Brobdingnagian scale, in the same kind of "vendor financing" that made the recent telecomms bubble such fun -- while it lasted.

Articles about Asian countries often remark on the enormous savings accumulated by their citizens. But nearby there are usually also comments on the high levels of bad loans in their banking systems. If 40% of the loans are unrecoverable, does it not follow that 40% of the "savings" are illusory?

In Japanese magazines such as "Ekonomisuto" and "Tôyô Keizai", I read that Japan's pension systems, both public and private, are under heavy stress due to the combined effects of loan losses and zero-interest-rate policies. One result is that foreign (e.g., US) bonds are being bought in desperation for yield. Though some would deem this unwise, citing devaluation risk, it seems that devaluation is no longer a possibility, as it would mean an end to the world as we know it.

Like Catherine L. Mann, I long thought our trade and current account deficits clearly unsustainable, but have recently concluded that the unsustainable is now indefinitely sustainable. We are indeed, in a new era, one in which the ideas of John Law* can be fully realized, his Banque Générale reincarnate as the FRB. Thanks to modern innovations such as the FDIC and the hedging away of all risk through derivatives, the bank runs and defaults that brought Law's system down are no longer possible. It can't happen here.

*http://cepa.newschool.edu/het/profiles/law.htm

anne,

A couple of quick comments.

The rent on my 3 bedroom 2 bath apartment in Ravenswood neighborhood, Chicago had not change in 3 years. My share of the rent is less than what I would paty for heat+condo fee+ property tax on a same size condo. Landlords are looking tor tentants in neigbhorhoods where it use to be hard to find an apartment. Also there are lots of unsold condos that have been on the market for over a year. In fact there are entire buildings where the only occupants are renters squatting for the flippers. However, there are still lots of new expensive construction.

I think that one factor may be that so many folks fot burn in the Tech bubble that they listen to investments pundits on cable news shows like Suzie Orsman and put all their mone into real estate or real estate based investements REITS. There has been a massive investment shift out of frying pan and into the fire.

Clearly what is different it that the public no longer sees their homes as place to live or even as a hedge against inflation, but as a primary investment. That may explains the premium they are willing to pay.

I wonder if the lousy investment advice the public gets from cable tv and AM radio is factor. Also given that the Real Estate sections are the large part of the Sunday paper can you expect the print media to cover this story accurately.

jm, a 20 yr observer, writes "...the unsustainable is now indefinitely sustainable." siding with Mann who just got tired of crying wolf.
Or does he? --he concludes with the line:"It can't happen here."
Nothing prepared me to take this sarcastically but I do. You are either a very polished writer or I am having a bad day.
There was a recent post at PrudentBear that detailed the relationship between Japan's interest rates and our TBill's rate that might interest you. Warren Pollock argues there, that these interest rate diffentials are used to support the dollar that most of us thought would have fallen far faster than it has. I'd be interested in your take on this:
http://www.prudentbear.com/archive_comm_article.asp?category=Guest+Commentary&content_idx=35726

Anne -- the economy continuing to have moderate growth like it is now has a very low probability.

I've always described the economy as being like a bike when it is growing rapidy it can absorb shocks very easily. But when it is weak the least bump can cause real problems.

If trend growth is 5%, it can swing from 2% to 8% with no problems. But if the trend is 2%, the same three percentage point swing about the trend can put you into negative territory.The economy is rarely actually stable, it is either rising strongly or weakening rapidly.

On perceptions -- read David
Warsh at www.economicprincipals.com today.

He summarizes a very good Brookings study on how people perceive economic facts. It finds that reality has very little impact on how people perceive the economy or their interest.

An excellent set of posts from JM through Spencer. There is much for me to think through, and that is what I am now about.

Comments: Prices of homes from 1953 to 1995 moved in line with inflation. From 1995 to the present there has been a 35% price increase above inflation. Prices of homes in selected urban areas have risen significantly faster than the national averages. Clearly the housing market has changed.

The private and public, domestic and international, debt Americans are accumulating is a serious long term problem. At the very least investment income is increasingly flowing out of America to international holders of our debt. We need to learn to save and we need to limit the growth rate of our public and international debt. However, there is no specific level of debt that will suddenly be self-limiting. The growth of debt could continue with little noticeable problem for quite a while.

What has surprised me this year is the quite of our markets. Whether stock, bond or currency markets, there has been little volatility. We have a job creation problem, for we are growing too slowly, but the problem while dramatic for individuals has not led to a fiscal focus on solution. So, there is a quite to markets and to the economy. We are vulnerable to shocks, but even the impact of 40 dollar o barrel oil has so far been muted.

Sure, I can quite spell quiet.

Anne, Spencer, anybody. Any idea what the impact of the alternative minimum tax will have on the consumer spending side of the equation in the next cycle? I believe that this factor, along with the fact that the rise in the level of real wages has been virtually non existing in this period of "economic recovery" spells recession compounded by higher interest rates. "It can't happen here..." I think we are about to find out if Mr. Bush is re elected.

The Alternative Minimum Tax bite will be damaging enough that I think we can be sure the tax will be set aside. Possibly the tax will be set aside year by year, but the prospects will be damaging enough that Congress will act.

anne,

Assuming Bush is reelected, heaven forbid. I would agree that the AMT is a trainwreck in the making but setting it aside would require Bush to "Move His Lips" and cancel his upper class tax cuts. I just do not see Shrub doing this. He would rather see the US economy circle the bowl before having the courage/foolishness to offend the wing-nuts in the Republican party.

Then again, maybe they shouldn't have raised rates to begin with. A few of us said as much at the time.

JG

Then again, maybe they shouldn't have raised rates to begin with. A few of us said as much at the time.

JG

"Then again, maybe they shouldn't have raised rates to begin with. A few of us said as much at the time."

I do not understand. The AMT goes back to the Administration of Lyndon Johnson. Tax rates have been lowered these past 4 years not raised. However, no matter what is done about continuing recent tax cuts, the AMT has to be set aside.

calmo:

My recollection is that the amount of dollars bought just by the BOJ acting directly during the period March '03 through March '04 was $304 billion. Moreover, the Japanese government had authorized the expenditure of about $1 trillion more (I suspect to deter speculators from trying to challenge them as Soros did the Bank of England). Since the Japanese GDP is about half ours, that is the equivalent of the Fed buying $600 billion of yen, and having Congressional authorization to buy $2 trillion more.

For decades the Japanese government has depended on exports to keep the people employed, though to do so requires that they malinvest the nation's savings through measures such as the above.

Because a large part of China's trade surplus with us is in products whose production costs are largely in expensive high-tech parts they must import from Japan, Japan's true trade surplus with the US is probably around $200 billion per year, about twice the directly visible imbalance.

Keeping in mind that going forward we must pay interest on the awesome amounts we have borrowed from foreigners, to eliminate our current account deficit would require us to change from running a trade deficit to running a signficant trade surplus. How much would the dollar need to fall to enable this? I suspect about 50%. The disruption would be enormous. Here, huge numbers of people would need to change careers from retailing and distribution to manufacturing. Wal-Mart/Target/Best-Buy/etc. stores would need to be turned into factories. In Japan, they would need to make similar changes in the opposite direction.

The decades-long deliberate subversion of market forces by the Japanese government has created monstrous distortions in the world economy by making it appear that Japan has comparative advantage in areas where it in fact does not.

But they are riding the tiger (and have pulled us on board with them). There's no easy way out of this, and since they're the lineal descendants of the people who were running the country in WWII, it's not surprising that they're refusing to face reality. In 1943 the Japanese high command received staff analyses that told them defeat was just a matter of time. But rather than accept the need to change course and sue for peace (as the German high command did in WWI when they came to that conclusion), they kept on fighting and hoping for a miracle.

Then, they were ready to fight to the last bamboo-spear-armed schoolgirl. Now the schoolgirl is 80, and they're ready to loan us the last yen of her retirement savings.

calmo:

Re "It can't happen here."

If it can, we are going to live in very interesting times.

http://www.nytimes.com/2004/09/19/business/yourmoney/19comm.html

Commodities Are Riding on China's Coattails
By JOSHUA KURLANTZICK

THROUGHOUT the first half of this year, investors in commodities fretted about China. They worried that its economy was in for a hard landing, as construction, property values and equities all seemed to be overheating.

Such a landing could be disastrous for commodities companies, which have profited from some of the strongest global demand for resources in decades. Much of that demand has been driven by China, which now accounts for 30 percent of world coal consumption and 40 percent of steel consumption.

So far, however, the fears have generally not been borne out. Loan growth in China slowed by 7 percent from August 2003 to August 2004, and while inflation has remained strong, it has been below forecasts. China's consumer price index rose by an annualized rate of slightly more than 5 percent in August. Many analysts now say that China's economy will grow 9 percent this year.

As a result, said Phil Flynn, senior market analyst at Alaron Trading, a futures and options brokerage in Chicago, commodities and shares of mining companies around the world, which have posted sizable gains over the last two years, are still a solid long-term bet. 'We're in an era of tremendous opportunity for commodities, and it's going to be one of the biggest sectors not for one year, but for 5, 10 years,' Mr. Flynn said.

Moreover, commodity companies do not have to deal with the same headaches as manufacturing or service businesses supplying China. After all, commodities like coal are tough to pirate, and their producers do not need to worry about winning over Chinese consumers to a brand name.

What's more, said Thomas K. McKissick, managing director at TCW Asset Management and lead manager of TCW's Galileo Large Cap Value fund, commodity prices have been so low for so long that even recent demand has not bolstered supply enough. 'You were in a 20-year bear market for commodities,' which reduced capacity, he said, noting that China still had little of its own manufacturing and transportation infrastructure in place.

jm, thank you for your thoughtful reply. The Pollock piece broke new ground for me in understanding the stability of "unsustainable". Let me exerpt the conclusion:

In summary, interest rate differentials:

(1)allow the United States to tap Japanese savings;

(2)provide the Japanese treasury and banking system with the opportunity to make arbitrage profits;

(3)weaken the Japanese yen, which in turn provides the domestic Japanese economy with jobs;

(4)establish Japan as the only buyer capable of absorbing US debt;

(5)put an artificially low cap on US long-term interest rates, thereby enabling the US to borrow obscene amounts of money and service its debt;

(6)enable finance-based US economic activity, including artificially low long-term rates, to be used to facilitate mortgage lending;

(7)make the United States an importer of Japanese monetary (interest rate) deflation, and;

(8)support the US dollar.

He is not optimistic about its longevity, you?

Have you ever noticed that when it comes to Republican hacks, they always accuse you of what they are most guilty of. Ann Coulter's Treason is a good example, where she lies her way through 200 pages to convince you that anyone who ever put a D beside his name, from the dog catcher to the President, sold secrets to the Soviets. Why are Repugs so desparate to affix the traitor label to Dems? Because the Repugs are the traitors of course. The foremost example being the fine republican families of the 1940s whose companies traded with the Nazis right though the second world war. Later they joyfully helped Nazi war criminals leave Europe through the Vatican highway to Argentina, the US, Canada and Australia; taking a cut for moving their assets as well as their person.
In light of this, the Bush family alliance with the House of Saud speaks for itself.
If you want to betray America, vote Republican.

So here we have stutterus dickus trying to convince the general reader that to vote Democrat is to bancrupt the nation. The same rule applies, the rethug always covers his own sins by accusing his opponent of his crimes. Bush's fiscal train wreck is staring us in the face and the rethugs don't want joe public to wake up and smell the betrayal. Clinton proved that Dems are the party of sound fiscal management by enforcing pay as you go and giving Congress its only surplus in decades. The jobs flowed from the sound policy. Incidently it also put supply side utopianism in its coffin by matching robust job growth and GDP growth with higher taxes on our betters.

So yes gentle reader, interest rates are weakening in the face of Bush's strenghtening in the polls. But is it a vote of confidence? Why do interest rates fall? Well sometimes they fall because you are in a low inflation environment, but that has been the case now for 8 years and there has been no change here, so that can't be it. Wait a minute don't interest rates fall when economic activity slows down? When the fed keeps its rate down to stimulate demand because things are bad? Isn't this an anticipation of the economic weakness that will follow a Bush victory? Go figure ... a vote of non-confidence by the market in Bush to do what is needed to put Americas house in order.

Don't let the manipulator up thread fool you.

You figure, Nem, that jm is about to ( Oh No!) fool me? And there I was trying to tie him down to Pollock's piece. Most of us are aware of Japan's exit from the fx market and the immediate adjustment in the $US/Yen. And we know that they can come back in with the wad that jm mentions, should that be in their interests. Pollock's piece looks at Japan's purchase of US TBills. It's interesting if you have not made the connections to savings rates of 0% overthere.
Nem asks:
"...interest rates are weakening in the face of Bush's strenghtening in the polls. But is it a vote of confidence?"
Could be (long term) interest rates are weakening in response to falling mortgage business. Could be that if the residential housing market tips, we'll have to find somthing else to drive the economy --growing soy beans perhaps?
It may have little to do with an alleged confidence in Bush and a lot to do with a tapped-out consumer, no?

calmo:

The eight conclusions you list from Pollock's essay are corollaries and side effects of what I wrote about. He's just looking at the same things from a different vantage point. The question is, how long can the unsustainable be sustained? Will the system collapse? Or will it simply congeal?

Another take on the subject of Asian governments acting so as to keep US interest rates low, and the sustainability of the situation:

http://quote.bloomberg.com/apps/news?pid=10000039&cid=mukherjee&sid=a.7B2SsYPdIM

And a much less paranoid, much more interesting take is here:

http://www.morganstanley.com/GEFdata/digests/20040921-tue.html

Andy Xie's writing on China is consistently excellent.

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