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Economy Glass Half Empty or
Half Full? |
Week of Monday,
May 19, 2008 |
Mortgage and 10-year T-notes
tried their tops all last week (6.25% and 3.92%, respectively), looking
like they would break upward... and held. Rates improved Friday, but a run
into the fives will require a weakening economy. Name your poison.
The stock market's persistent strength makes sense to all who believe that
the economy bottomed in March, that we will not have a real recession,
that the credit markets are healing quickly, that overseas strength will
prop our economy and big-business profits, and that the tax rebate checks
will ensure a good summer.
Piece of cake. Traders call it the Check Republic.
Some data support that argument. A little. The NFIB small-business index
stabilized in April, but only a half-tick above March, the worst in 28
years. New claims for unemployment insurance are flat but high. The
turndown in rates late Thursday followed reports contrary to
worst-is-over: April industrial production tanked .8%, and capacity in use
fell to 79.7%, the first time under 80% since 2005 recovery. Consumer
confidence fell again, now to a June 1980 level (we remember, and would
rather not).
The big unknown is overseas. Retail sales in China rose an annualized 22%
last month, one-third of that gain was inflation at 8.5%, GDP 10.5% (after
inflation). How long can that oil - and commodity - popping growth
continue? Europe is in a worse collision between central banks, inflation,
and growth than we are, the UK worst of all: inflation out of bounds above
3%, house prices and economy crumbling, the Bank of England unable to cut
from its 5% benchmark, where our Fed was last August.
April CPI rose only .2% overall, the core rate .1%, as gasoline prices
were "seasonally adjusted" to a .2% decline. That report triggered
widespread rage among civilians, and contempt among bond traders (CNBC
captured a crew wearing chef's hats to protest cooked numbers). These
objections are foolish. The Fed understands distortions, studies dozens of
inflation indicators, and has no interest in political cover from
artificially low reports.
Given that argument, and the preserve-economy/fight-inflation conundrum
facing the world's central banks, herewith a brief review of inflation
principles.
Classically, inflation is "Too much money chasing too few goods and
services." Note that both "toos" are relative, hence two different kinds
of inflation: cost-pushed and demand-pulled. Note further two different
sorts of demand-pulled: the money-printing kind (Weimar 1922-23), and the
often-associated but different demand from an "overheated" economy. The
deadly-dangerous inflation virus: when the two forms of demand-pulled
combine into a "wage-price-spiral."
Inflation in the US today is cost-pushed. The Fed is not printing money in
its efforts to resolve the crunch, nor does its 2% cost of money reflect
easy credit. Credit today is much tighter than when the wheels came off
last August. The exquisite discomfort here is caused by fixed incomes
(wages capped by foreign competition) versus rising costs for energy,
food, and health care. Other than pain, the effect is to force households
to shrink spending on everything other than the three pushers.
Deflationary!
On the Continent and in the UK inflation rates are similar to the US, but
inflexible labor markets (unions and laws) prop up wages and threaten a
wage-price spiral; that threat forces higher central bank rates there than
here, ECB at 4% vs. our Fed's 2%.
Asia, India, Russia, the Middle East, and several emerging nations are in
full-blown wage-price spiral and overheating beyond capacity, to a degree
and kind making the 1970s US look disciplined. The authorities in none of
these places appear to have the political clout to tap the brakes, let
alone to stand on them.
Here, the Fed is trying exactly what it must: keep GDP growth close to
zero -- not going negative if it can -- until cost pressure subsides. In
the Eurozone, same deal but lagged six months to a year. Then (all on
knees to pray) the slowdown will spread to Asia, breaking commodity and
food prices, and perhaps mortgage rates as well.
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