US inflation hits highest level since 1990

July 17, 2008 | posted by Michael Baxter in US economy, inflation | comments (0) | Print This Post

It is difficult to say it better than Capital Economics did yesterday. “The news on headline CPI inflation couldn’t have been much worse,” said Paul Ashworth, senior US economist at the consultancy.

Consumer prices rose by no less than 1.1 per cent in just one month in June. Energy prices rose by a simply staggering 6.6 per cent – that’s one month, remember.

The annual inflation rate hit 5 per cent. You would have to rewind the clock back all the way to 1990 to see the last time inflation in the US was that high.

Yet, inflation with food and energy taken out really wasn’t that bad. Prices were up 0.3 per cent in June, taking the annual rate to 2.4 per cent.

Combine that news on inflation with the sentiments expressed in the latest set of minutes from the Fed’s last interest rate setting meeting, published yesterday, and you could be forgiven for assuming that US interest rates are about to rise.

The minutes said a “firming in policy would be appropriate very soon.”

It may have only been a couple of weeks ago when the Fed last sat and deliberated, but the picture has got a lot more gloomy since then. Since then the Fannie Mae and Freddie Mac news has broken. Markets have tumbled, the US banking crisis has deepened. The Fed now has all guns firing, trying to avert a deepening crisis.

The feeling is that despite inflationary worries, rate cuts, maybe several, will follow.

Does this mean inflation in the future? Well, in the longer term inflation occurs when demand is higher than supply. And frankly, looking at the state of the US economy, it seems unlikely demand will create inflationary pressures for a very long time.

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Bernanke and house sales give hope to Uncle Sam

June 10, 2008 | posted by Michael Baxter in US economy | comments (0) | Print This Post

Rome wasn’t built in a day; when bubbles burst it takes time before they hit bottom, and even longer to climb back up. 

Sometimes forces can build which you would expect to stop the rot, yet falls can continue.  This is because there are multiple forces at work.  It takes time before new forces make an impact.

Yesterday, news broke that US sales of US pending homes jumped 6.3 per cent in April.    

The trouble is, inventory levels are so high, that it will take time, and for as long as this inventory makes it a buyers’ market, prices will fall.

Capital Economics said: “We suspect that the bottom for housing sales and construction may be closer than some people seem to think. House prices will continue to fall for at least another year or two given the excess inventory of unsold homes on the market. But sales have already been falling for a couple of years now and should have fully adjusted to the complete collapse in all non-conforming mortgage lending.”

Yesterday, the top man at the US Fed, Ben Bernanke, spoke out too.  He said, “Recent incoming data, taken as a whole, have affected the outlook for economic activity and employment only modestly.” Encouragingly, he added, “The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”

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Ben flies through the sky like a hawk

June 4, 2008 | posted by Michael Baxter in US economy, inflation | comments (0) | Print This Post

And with just a few words he was the golden boy again.

Fed chairmen are surely the most commonly vilified men in business.  Well, at least they are up there with private equity and bank directors.

Ben Bernanke put his foot down, and down pumped an awful lot of gas into the US economy over the last few months – the result – it looks increasingly as if the US will avoid recession, but inflation has burst onto the scene.

Actually, US inflation is not really that awful, yet, but the fear is that the high price of oil will exert pressure down the line.  Alan Greenspan slashed rates earlier this decade, and now, or so goes the argument, we are paying the price; the fear is Bernanke has made the same mistake.

The US rate of interest is 2 per cent, meaning the real rate – that’s after inflation – is negative, but then again, credit is hard to come by, banks are charging interest out at much higher rates than official Fed rates – maybe it doesn’t matter.

Others say the Fed went wrong because it both pumped money into the system and cut rates.    The ECB by contrast has just gone for the money – and, or so goes the argument, as it has to be repaid, the move is not inflationary.

But what has Ben been up to?  Is he aware of the inflation danger?

Yesterday he spoke, and in particular he zoomed in on the falling dollar.  “In collaboration with our colleagues at Treasury, we continue to carefully monitor developments in foreign exchange markets,” he said, and the Fed was “attentive to the implications of changes in the value of the dollar for inflation and inflation expectations.”

And then he struck the hawk note. The Fed will “formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations.”

So what does it mean?  The US is unlikely to cut interest rates any time soon.  Capital Economics said, “If oil prices drop back later this year there may still be scope for a further reduction in rates.”

The markets also concluded that the time of a free falling dollar with the Fed doing nothing has ended, and the greenback rose sharply on that and the price of gold and oil fell.

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It’s back, but can we return the inflation genie to its bottle?

June 2, 2008 | posted by Michael Baxter in inflation | comments (2) | Print This Post

That Ben Bernanke knows a thing or two about depressions.  If there is anyone alive today who has studied the US economic depression of the 1930s more than the current chairman of the US Federal Reserve, then it would be a surprise.

That is why many have been saying we will never see a repeat of that saga, nor will we see a repeat of the lost decade suffered in Japan, not while Ben is in charge anyway.

There is one snag with that argument – not all downturns are the same.  The 1930s, and Japan’s lost decade, saw a crash in asset prices followed by deflation.  And Mr B has been doing his best to ensure those characteristics are not repeated here.

But, and this is the danger, supposing it is not like that.  Supposing the real threat is a return of 1970s style inflation, combined with sluggish growth – stagflation.   The danger has to be that Ben, by slashing interest rates, is making things much worse.

Think of it this way.  Imagine the economy is like a shower.  A shower in which the water supply only responds slowly to a turn on the tap.  So, one moment it is too cold, you turn up the hot tap, but it is still too cold.  What do you do?  Wait a little longer to see what happens, or turn up the hot tap some more?

The danger is that Ben Bernanke has turned up the hot tap before his previous tweakings had been given sufficient time to work. The result – well, very shortly scolding water might come flooding out.

But the analogy ends there. The economy is not like a shower – you can’t turn the inflation and growth taps on and off  like that.  Inflation doesn’t come pouring out one moment, and reduce to a trickle the next.  Instead, it has been likened to a tube of toothpaste.  Stopping inflation is the equivalent of squeezing toothpaste back into its tube.

It is an important point, because right now is a crucial moment.   It is possible that inflation is being allowed to build, and that down the line it will come gushing out – across the world.  The signs are certainly there to suggest this may happen.

Alternatively,  if you believe oil and food prices are displaying all the hallmarks of a bubble, which will burst, sending prices spiralling down, we may re-discover deflation, after all.   In which case Ben will seem like a genius – and may go down in history as the Fed’s best chairman to date.

Which scenario is right? In today’s issue we take a look at both sides of the debate. And to start with, let’s take a look at oil. Which way next for the black stuff – read the next article.

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Economic snapshot

May 6, 2008 | posted by Michael Baxter in UK economy, US economy, credit crunch | comments (1) | Print This Post

The US is tottering.    Latest figures say the US economy expanded by an annualised rate of just 0.6 per cent in the first quarter of 2008.   Opinion is still mixed as to whether Uncle Sam will fall into full blown recession, or merely go close. Many expect recession, but in contrast the National Institute of Economic and Social Research has forecasted growth of 1.3 per cent this year – not good, but neither does this signify recession.

In the UK, it forecasts growth of 1.8 per cent both this year and next – that marks a slow down, but if the forecast proves right, the dream of uninterrupted economic growth will remain intact.

Recently, some leading and highly respected economists have suggested the credit crunch has passed the halfway stage – but others are still describing the crisis as the worst ever peacetime financial crisis.

In the US, this particular downturn is unusual because it has been led by falling house prices – unlike, for example, the previous recession which was caused by factors such as the dot com crash and 9/11.

House prices are now falling in the UK.    It has now become a question of how big the falls will be, and for how long.

But opinion is mixed on how much this matters.  Some say that there is so much spare equity in the UK housing market, that even if prices fell by 10 per cent, only a relatively small number of property owners would face negative equity.

Furthermore, many argue that consumer spending is only slightly influenced by house prices, so a fall in house prices will not lead to a corresponding fall in consumption. Others say this flies in the face of common sense – and of course falling house prices will lead to falling consumption. 

Furthermore, they argue, house prices were pushed up too high by the irrational belief that house prices only ever go up – that the housing boom was at heart a speculative bubble and that house prices will overcorrect on the way down.

Bull points Bear points
The current chairman of the US Federal Reserve also happens to one of the leading academic experts on the 1930s depression.   Ben Bernanke spent years studying what could be done to avoid a repeat of that unhappy era – and he has been putting this knowledge into practice.   No two recessions ever have identical causes.  The current financial crisis has significant differences with the 1930s depression – in particular the effect of globalization and rising commodity prices.  What would theoretically have worked in 1929, may not work today, and could, by stocking up inflationary pressures, make things worse in the long-term.
The Bank of England has instigated an unprecedented measure to push liquidity back into the markets – by allowing banks to swap triple A, but illiquid, mortgage security into  Treasury bills; this should restore inter bank lending. Too much money was lent earlier this decade, creating too much debt.  As house prices fall both in the US and UK, much of this debt can not be repaid.  No amount of new money can alter this fundamental truth.
Warren Buffett, the world’s richest man, recently indicated recently that right now is a going-buying opportunity as he announced plans for major buying.   In general, economic slowdowns often represent good buying opportunities.  But given the pessimistic economic forecast, equities have not yet fallen to the level one would have expected.    George Soros recently predicted another dip to follow.
Thanks to the rise of economies such as China and India, the global economy is no longer reliant on the US. But the US remains the most important economy.  The dollar is falling and so are US imports – it remains to be seen if the global economy can afford  to see its biggest customers tighten its belt.
The US government is boosting the US economy via a massive $150bn tax credit – which will boost some households by $1,200.   Keynes once said in times of a debt crisis, cuts in interest rates are ineffective, as the last thing you need to do is try and get people to borrow more.  He likened this to “pushing on string.”    But  the plan to give back tax to US consumers is exactly what Keynes would have recommended. Many expect US consumers, who are so worried about prospects, to simply save the tax credit.    In any case, the extra amount US consumes are spending on oil could counter-balance the benefit of the tax credit.
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Bill and Ben: US bills set to rise, but Ben slashes away

January 31, 2008 | posted by Michael Baxter in US economy | comments (0) | Print This Post

And so the Fed duly obliged yesterday. In cutting the rate of interest by half a per cent, just a week or so after its last cut, it has certainly been the case that this January has seen the Fed try its best to ease the pain of this darkest of winter months.

And now the US rate of interest is 3 per cent. Until the beginning of last September, the US rate of interest was still at the relatively high level of 5.25 per cent - and no one was predicting such sharp cuts in rates - although in fairness, even as far back as 2006, Capital Economics had said the seriousness of an impending slowdown in the US housing market had been underestimated, and it had predicted substantial falls in US interest rates in the years ahead. Although, not even it foresaw quite such rapid cuts in rates.

The Fed’s remarkable run of rate slashing kicked off last September with a half a per cent cut. October and December both saw quarter of a per cent falls, but January takes the biscuit, with the Fed’s official discount rate falling by 1.25 percent in the month.

But, it seems the rate cutting is still not at an end, with many pundits predicting at least one, maybe two more quarter of per cent cuts.

Of course, with the rate of interest that low, all those borrowers who are currently struggling to make ends meet will suddenly find themselves a lot better off. Couple this with George W’s $150bn tax break, currently winging its way through the US political system, and then throw in Ben’s fleet of helicopters carrying fresh and glittering new money, and there can be no denying the US is doing what it can to keep the US economic machine ticking over.

Whether it is a such a sound practice to kick-start the US by trying to boost consumers, when it was their spending that created the mess in the first place, is a moot point, but setting aside that argument, will this line up of aggressive action work?

Well, one things seems sure, the dollar must surely have further to fall - although maybe not against the pound. With a cheap dollar, of course, the price of goods imported to the US, measured in dollars, will soar. The danger has to be that that the falling dollar will, in effect, counteract the benefits of the monetary and fiscal stimulus, and US inflation will soar.

It is also debatable whether the US, with its funds already strapped, and with the need to find another $150bn, will be able to continue to afford, how can we put it, proactive foreign policy, when the dollar is losing so much of its clout.

As for the here and now. Yesterday also saw the release of the first set of data relating to US growth in the last quarter of last year. The economy expanded at an annualised rate of just 0.6 per cent, from the last quarter of 2007 - or so says the first draft of the official statistics.

Now think about that, if the annualised rate is 0.6 per cent, then the quarterly growth must be around 0.15 per cent. By contrast, the UK expanded by 0.6 per cent in its final quarter - so says the ONS data.

Furthermore, the consensus expectation had been for 1.2 per cent annualised growth in the US, even Capital Economics, arch bears, predicted 0.8 per cent annualised growth.

Now, US figures are compiled differently from the UK’s. Less emphasis is placed on the quarter on quarter figures, rather, instead, emphasis is placed on the annualised data. So US growth only needs to slow by a tiny amount and it could be argued the it is in recession.

There’s lies, damned lies and statistics. But it appears that those who are saying the US is already in recession, might, at least by one definition, be telling the whole truth.

us growth

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Fed bails out stock market

January 23, 2008 | posted by Michael Baxter in US economy, credit crunch | comments (0) | Print This Post

In his book, Age of Turbulence, Alan Greenspan repeatedly stated that it’s not the Fed’s job to worry about the stock market. Rather, the Fed is charged with the task of striking the right balance between inflation and growth in GDP. (This differs, by the way, from the Bank of England and European Central Bank, which are supposed to focus solely on inflation.)

Yesterday, the Fed did the opposite of what Greenspan suggested it should do, and quite clearly put the interest of traders and investors above all else.

The announcement of a 0.75 per cent cut in rates, the biggest one-day cut since 1982, was relevant to US inflation and US growth in one respect only.

The move carried massive psychological impact. If the chairman of the Fed was a PR man, he would have recommended yesterday’s move. Bernanke certainly won the headlines – and in so doing sent a message to banks, borrowers and consumers: “Don’t panic,” he said, “Uncle Ben is here to help.”

But that was it. The economy is not like a Formula 1 racing car, which reacts almost instantly to a press on the brakes, or pushing down the gas. Rather it is like a cruise liner. Perhaps one of the most memorable moments in James Cameron’s film ‘Titanic’ was when the iceberg was spotted, and despite the efforts of the crew the ship just couldn’t turn around fast enough.

The relationship between changes in the rate of interest, and inflation and growth, has a time lag built into it. It can take as much as two years before a change in rates has its full effect.

If the Fed had chosen to lower interest rates at the end of the month, when it was due to meet, the economy’s performance would not have been affected – at all.

If the Fed had made its announcement yesterday afternoon, it would have made no difference. Instead it went for maximum impact, revealing its latest cards first thing in the morning – so that the markets had all day to ruminate on the move. So the markets had no reason to start the day off with a panic sale.

And in that one respect the Fed’s move was an unqualified success. Sure, the Dow was down 128 points, but some analysts believe that if the Fed had not made its announcement, the index could have plunged by 600 points, or more.

Many economists believe the US could be in recession – right now – even as you read this. Yesterday’s move will have no impact on this.

But, the rate cut will give borrowers a huge lift. Both indebted businesses and individuals paying interest at a rate that changes with the official US discount rate, will soon be much better off.

Couple this with George W’s move earlier in the week to give out a $150 billion tax boost, combine this with the money flooding into the US from sovereign funds, shoring up bank balance sheets, then throw into the pot the various occasions in recent weeks in which the Fed has pumped money into the system. Right now the US is fighting back.

Was Bernanke right to take such drastic action yesterday? In an interview on Radio 4’s Today programme, George Soros said he was right. “I think you do have to rescue markets, otherwise you go into depression like you did in 1930,” he said.

There are serous risks with the move, however.

If in cutting interest rates the Fed makes things easier for debtors, and enables people to avoid bankruptcy, or house possession, then the move was a good thing. If on the other hand, it encourages a new borrowing frenzy, if people just go out and borrow some more, perhaps they borrow to pay off existing borrowings; then that is a bad thing.

If the cut in rates leads to further falls in the dollar, and if the price of oil starts to go up again, then inflation will pick up.

Ben Bernanke once said, famously, that the solution to a credit crisis was to get into a helicopter and spray money across the land. This earned him the nickname of helicopter Ben. Well, he has done that. In this week’s Economist, the front cover showed a fleet of helicopters, this time depositing money from the sovereign funds. The last few weeks have seen the economic equivalent of shock and awe, a full-frontal aerial strike – helicopters carrying money from the Fed, helicopters from the People’s Republic of China, and Arab states, carrying economic aid; F15 jets firing $150bn-worth of tax boost, and now a missile loaded with a 0.75 per cent cut in rates.

But, supposing it is not enough?

George Soros said this morning, that he believed the US will hit recession, and the UK may well follow in its wake.

Maybe the battle we are now seeing being fought is not to try and avoid recession, it is not to try and kick-start the economy. Rather, we are seeing an attempt to avoid the US following Japan, and hit depression. The fear has to be that the price for avoiding this depression is even more debt – increasing the dangers of an even-more severe economic shock in the years to come.

What we really need is not for an air strike carpet-bombing the economy with capital – what we really need is the foot soldiers of China and India – the consumers, to go out and spend more of their county’s new wealth.

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