February 21, 2008 | posted by Michael Baxter in US economy | comments (0) |

This is the strange thing. As you know the Fed is doing all it can to get the US economy moving again. The last few months have seen an extraordinary run of interest rate cuts, with the official cost of borrowing falling by 2.25 percentage points to 3 per cent in just four months. And yet, US inflation, the very thing that the rate of interest is supposed to combat, is going up almost as fast as rates are going down.

The latest set of data tells a sorry story. The annual rate of US inflation rose to 4.3 per cent in January, while the underlying rate, that’s the data with food and energy taken out, rose by 0.3 per cent in the month from December to January – that’s the highest rate of monthly inflation measured by this index in 18 months.

And yet, just to repeat, the US interest rate is 3 per cent – or, to put it another way, the real cost of borrowing is minus 1.3 per cent.

It seems the Fed is not merely putting the US growth horse before the inflation cart, it is putting it before just about everything else, too. At a time when US citizens should really be saving more, after all, Uncle Sam too is sitting on a demographic time bomb – it is encouraging its citizens to spend their way out of trouble. It really is a case of the pub turning to the drunk, and saying, “Here, have another drink, that will make you feel better.”

You can see the Fed’s dilemma – just take a peek at its latest projections for growth, also out yesterday.

The Fed now reckons the US will expand by between 1.3 and 2 per cent this year. The last time it stuck its fingers in the air, felt the economic breeze and pronounced its projections for growth – it predicted growth of between 1.8 and 2.5 per cent.

This does raise a worry. For some time, the Fed’s projections have been more optimistic than projections from elsewhere. Yet, if anyone should know what is going on, it should be the Fed, so one is naturally inclined to believe what the Fed is saying over all the doomsters. Yet, it keeps downgrading its estimates, the last projections were announced last October. So it is like this. The Fed surprises everyone and says things are not as bad as others are saying. We believe the Fed. Then, four months later, it changes its mind, and says well, actually, what people were saying at the time of the last projections was perhaps about right, after all. But by then, the doomsters have got even more pessimistic. Is the Fed just behind the curve?

Now, some might argue, of course, that as the economy is slowing, inflation will fall eventually – there must be forces beavering away in the background having a dampening effect on inflation – give it time, goes this argument, and the Fed’s rate cut will be justified.

There is one snag with this argument. Some put this era of low inflation which we have been enjoying for the couple of decades down to clever central banks and new wisdom amongst economists on what causes inflation. In other words – inflation has been low because economic policy has been right.

But maybe this analysis is wrong. Maybe, actually, the era of low inflation and high growth was a fluke. Maybe, the real cause of low inflation was, first, leaps in technology, leading to greater productivity, leading to an ability to produce more goods for less. Then the Internet helped promote price competition, and then, of course, we had the rising influence of globalisation.

Maybe all these effects have worked their way though the system now.

Some economists dismiss the recent surge in the price of oil and food and other commodities saying these are just one-offs – there will be no lasting inflation hangover. But maybe the factors that have led to deflation of other goods – are just as much one-offs.

In slashing rates now, when the likes of Alan Greenspan have been warning a new age of higher inflation appears to be upon us, seems to be a high-risk strategy.

In two or three years’ time, when, perhaps, Barack Obama is sitting in the White House, we may well find that the US, and in turn the rest of us, will be counting the costs of today’s policy decisions.

February 15, 2008 | posted by Michael Baxter in US economy | comments (0) |

All eyes turned to the US yesterday, where markets saw another nosedive on a string of highly significant developments, some bad, some actually quite good. But cut through all that, and all of a sudden a bright new idea shines through. Here is an idea which will solve all of Uncle Sam’s ills, and enable George Dubya to leave office while the economy is booming. There is just one snag – this clever wheeze could leave the US economy in a right sorry state – during the midst of the next President’s tenure.

Actually, there were three major developments yesterday:

Development number 1: Fed chairman Ben Bernanke and US Treasury Secretary Henry Paulson sat before the Senate Banking Committee yesterday, providing their latest testimony. Bernanke admitted that the US economy is in worse shape now than he had expected when he made his previous testimony. But, both he and Hank made a passing impression of a record that was stuck in its groove, when they repeatedly said the US would avoid recession.

And Mr Bernanke dropped a big hint that further interest rate falls are set. “The Fed,” he said, “will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks”.

But above all that the two men sounded bold triumphant notes of optimism. The economy “is fundamentally strong, diverse and resilient” said Paulson, adding, “I believe our economy will continue to grow, although its pace in coming quarters will be slower than what we have seen in recent years.”

And the two men say that while things will be tight over the next few months, as the full effects of the rate cuts and tax credit take hold, the economy will then recover nicely.

One senator at least was not impressed and said that both the Fed and US Treasury had “hit the snooze button,” but added he wasn’t trying to talk the economy down.

“If you’re trying to talk the economy up, I’d hate to see you talk it down,” retorted Paulson, triumphantly.

“I’m just trying not to hide my head in the sand,” replied the senator.

And from snoozing to wise-up, the most sprightly octogenarian former chairman of the Fed in the world today, Alan Greenspan, seems to have his eyes fully tuned in to the downwise. It was about a year ago now when he warned there was a third of a chance of a US recession. Then later in the year he said the chances were 50/50, but yesterday he went a step further. “We are clearly on the edge,” he said.“

And that’s development number two, the latest musings of Greenspan. “While we are at stall speed in the US at the moment, we haven’t yet seen the discontinuity that characterises recession,” said the 81-year-old. “American business was in such extra-good shape before this problem hit. Otherwise we would be talking about how long and how deep. We are not there yet.”

Then he gave a nice little soundbite “Home prices will continue to weaken,”‘ he said. “When a bubble breaks, you go to primordial fear.”

But while Bernanke was doing a passing impression of a headless chicken trying to calm everyone down, and Greenspan talked of “primordial fear,” data was revealed yesterday that really should have you sitting up.

Development three, was news that the US trade gap fell by 6.1 per cent last year. According to the Commerce Department, the 2007 deficit hit $711.6bn, from $758.5bn in 2006. Now there are two ways of looking at this deficit. You could say, “so what,” it is still twice the level seen in 2001. On the other hand, you could be celebrating the fact that this was the first time in six years that it didn’t go up on the year before.

There’s some more good news, exports shot up – well they were up 1.5 per cent. That’s what is needed, imports to stay high – meaning the US is still buying goods from the rest of the world, but exports rise to meet imports.

There is a snag. If you strip out petroleum imports from the equation – then actually imports were down 2.8 per cent – suggesting demand really is suffering in the US, after all.

But now it’s time to reveal the clever wheeze.

The rate of interest in the US is now down to just 3 per cent, from 5.25 per cent six months ago. It seems likely, based on what Mr Bernanke has been saying, that rates will fall further still, perhaps to 2.5 per cent.

But this raises some important questions. If the US economy is as strong as Mr Paulson says, why this massive cut in the cost of borrowing?

Well, we all know Uncle Sam is carrying a huge burden of debt – that’s fiscal, consumer and corporate debt. Inflation in the US is still north of 4 per cent – so if rates fall to 2.5 per cent, and inflation stays high, the real cost of borrowing is well into negative territory.

Such low rates will probably lead to further falls in the dollar, who knows, maybe it will go into freefall, and inflationary pressures will build and build.

But, hey, debt gets cheaper. Inflation will erode the true value of debt. Abracadabra, the Fed has solved the big problem that has been threatening to crush continued US success.

There is a snag, however. Such a policy will leave a legacy of inflation. Remember the Barclays Capital Equity Gilt Study 2008 we talked about yesterday “The net result of intensifying natural resource scarcities is an increase in structural upward pressures on inflation and a worsening trade-off between inflation and growth. To prevent the inception of an inflationary spiral, in the future, monetary policy-makers will have to become somewhat tougher than has been the case over the past two decades.” It said.

The Fed appears to be doing the precise opposite of what the Barclays Capital report says is necessary. It is taking the opposite approach of the more inflation-alert Bank of England and ECB. Somebody, somewhere, is horribly wrong, and if it’s the Fed, then the next President will pick up the can – and what a very heavy can it will be too.

February 8, 2008 | posted by Michael Baxter in US economy | comments (0) |

One of the curiosities of the US economy at the moment is this. If the roof is, quite literally, coming off the housing market, how is it that consumer confidence has managed to remain relatively robust?

For some time, economists have been warning that you write-off the US consumer at your peril – and it appears that Uncle Sam and Auntie Samantha’s appetite for spending is just as insatiable as ever.

It was the strength of the US consumer sector that recently led the National Institute of Economic and Social Research (NIESR) to predict only a mild slowdown in the US this year, with projected growth of 2.2 per cent – not half bad.

Yet, somehow it doesn’t gel. With other economists saying the US is already in recession, with the likes of George Soros talking about the worst economic crisis since World War II, how can the US possibly manage the growth projected by NIESR.

Well, maybe the answer is this. Maybe the US consumer, just like the US trader last year, has got his, or maybe it’s her, head stuck firmly in the sand.

According to a survey of 1,619 home-owners conducted by Harris Interactive for Zillow.com, just 23 per cent of the respondents said they believed their home had lost value over the last 12 months. In contrast, 36 per cent said they thought their home had increased in value, and another 41 per cent said it had stayed flat.

Now, Americans are by nature an optimistic lot. And so often this has been proven to be a good trait.

But last year’s exuberance by US markets seemed totally uncalled for, and this is not being wise in hindsight. We said so over and over again, and so events proved us right.

There is overwhelming evidence to suggest that US house prices have fallen over the last year, so there are only limited explanations for the results of this survey.

Firstly, maybe the data on house prices in the US is wrong – not likely. Maybe the survey did not use a sufficiently-large sample, or the results were biased in some way – perhaps focusing on regions where the market remained relatively strong.

But it seems the most likely explanation is that US homeowners have not woken up to reality.

Just like in the UK, there seems to a nationwide tendency to talk up houses by the bodies who are supposed to provide objective data. For example, the National Association of Realtors reckons house prices will be flat in 2008. Yet Merrill Lynch recently predicted a 15 per cent drop.

The truth is, someone, somewhere is wrong.

Someone is either far too optimistic, or someone else far too pessimistic.

Are the banks right with their pessimism, or are they merely blinded by their own mistakes? Warren Buffett recently called the problem inflicting banks to be “poetic justice” – maybe it’s a justice the banks just haven’t got their heads around yet.

February 6, 2008 | posted by Michael Baxter in US economy | comments (0) |

 There’s bad, and there’s downright dreadful, and yesterday’s latest economic data on the US fell into the second category. As a result, markets across the world did a nosedive.

These days, of course, we have become used to big daily falls in the stock market, with the Dow Jones falling by more than 300 points no less than five times last year. Even so, yesterday’s fall in the US was a big one, down by 370 points – only twice last year did the index put in a worse performance.

The collapse in shares followed a collapse in an economic index.

The Institute of Supply Management index for tracking non-manufacturing fell from 53.2 to 44.6. ISM indices usually only suffer falls of this magnitude when there has been a major shock, such as 9/11. For the index to suffer this big a slide during times of normal external conditions, is unprecedented.

Any score below 50 indicates that the sectors covered by the index are in recession.

Many economists were struggling to explain the big fall. Capital Economics, for example, said, “Given that the non-manufacturing ISM has typically rebounded almost straightaway from similarly sharp falls in the past, we would need to see at least two months of weak data before giving it much weight.”

It does seem that there is a possibility the US is talking itself into recession. Apparently, only 14.6 per cent of firms covered by the ISM survey said that the credit crunch was affecting their ability to obtain regular or additional financing.

Instead, it seems firms are more worried about the effect of a credit crunch on customers. But as Capital Economics said, “It is odd then that they themselves have been largely unaffected.

Right now, there are lots of oddities about the US economy. Despite the appalling mess of the US housing market, consumer confidence has not collapsed, as you might have expected. As a result of this, last week the National Institute of Economic and Social Research predicted that US growth this year would be above 2 per cent.

And yet, in the final quarter of last year, the US grew by an annualised rate of just 0.6 per cent – that is tiny and barely above recession level.

All we can say is, watch this space as the saga unfolds.  

February 4, 2008 | posted by Michael Baxter in US economy | comments (0) |

Last week, the National Institute of Economic and Social Research (NIESR) surprised many when it predicted only a modest slowdown in the US this year. It reckons the US will grow by 2.2 percent in 2008; that’s below trend, but hardly the stuff recessions are made of.

NIESR has a good track record too. It was a lone voice saying recession would be avoided in 1998 during the era of the East Asia, Russia and LTCM crises, for example.

Maybe banks are so pre-occupied with their own problems that they make the mistake of transposing their difficulties on to everyone else. They are blind, perhaps, to what is happening in the real world.

That may be true – but here is an individual whose credentials for predicting economic growth are every bit as impressive as NIESR’s, and he is saying the opposite.

Jim Rogers, legendary investor, co-founder with George Soros of the Quantum Fund, and famous for predicting the commodity rally in the late 90s, is altogether less sanguine.

“Conceivably we could have just had recession, hard times, sliding dollar, inflation, etc., but I’m afraid it’s going to be much worse,” he told Fortune magazine. “Bernanke is printing huge amounts of money,” added the guru. “He’s out of control and the Fed is out of control. We are probably going to have one of the worst recessions we’ve had since the Second World War. It’s not a good scene.”

Well at least Rogers and NIESR have something in common. They are both critical of recent moves by the Fed in slashing interest rates. Last week, NIESR said “It is possible that the Federal Reserve acted precipitately to technical fall-out from losses at Société Générale in France, which seems to have sparked much of the panic trading. The Banque de France informed the Federal Reserve of the matter in advance of their meeting scheduled for the following week. It is possible that if the Federal Reserve had waited for all the information they needed, they might not have acted, and indeed they may have damaged their credibility by their precipitate action.”

Meanwhile, Capital Economics seems to getting a little more bearish. Latest data revealed a fall in non-farm payrolls for the first time in four years in January. It’s been the strong labour market that has led some to predict only a soft landing for the US. So when data starts telling a worrying story on the US jobs markets, you know it’s time to fret.

Right now, the US rate of interest is, in real terms, negative. Even so, Capital Economics is worried about the US housing market. The Case-Shiller 10-city house price index fell by a record 8.4 per cent over the 12 months to last November. But “more worrying,” it says, “is the acceleration in the decline. The 20-city index fell at an annualised rate of 16.2 per cent between August and November.”

It says, “With the excess inventory of unsold homes at an almost unprecedented level, prices are likely to fall a lot further. This could constrain consumption growth for a number of years, although it may not cause an outright decline in spending in any one or more quarters. The further house prices fall, the more risk there is of a complete consumer capitulation. On the other hand, the monetary and fiscal stimulus now in place will have a potentially powerful offsetting effect on consumers in the second half of this year.”

And there you see the dilemma. NIESR doesn’t understand why the Fed has slashed rates and the US government has announced such big tax breaks. Jim Rogers too is criticising the Fed, but for quite different reasons, but Capital Economics is saying the only hope for the US lies with the measures announced by the Fed and George W.

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

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.