Monday, February 27, 2006


Fed Will Try To 'Keep The Party Going'

Bill Fleckenstein has this editorial on inflation. "As regular readers know, I believe that the CPI is woefully understated, for reasons related to hedonics, owner's-equivalent rent and substitution."

"Whatever the actual rate of inflation is in this country, it's higher than the reported year-on-year price increase of 4%. Whether the rate is 5%, 6% or some other higher number, I do not know."

"What gets me to talking about this is a rather glaring inconsistency. On the one hand, there seems to be denial about inflation being a problem, witness the repeated use of 'core inflation,' which is generally used to mean all the things that didn't go up in price. Then, contrast this sanguine view of inflation with the fear that Benny B. is going to get 'tough.'"

"If one wanted to make the case that inflation is not under control in this country and that the men at the Fed are serious and intent on doing something about it, that would be a logical, consistent argument. However, the men at the Fed are avowed inflationists. They blew up a stock bubble and refused to do anything about it. Ditto the real-estate bubble."

"And now, people are worried that the appointment of a Fed chairman whose academic endeavors revolved around fighting deflation means that the Fed will get tough? I'm sorry, but I just don't think that is logical. In fact, to me, it's a disconnect. The Fed has demonstrated over and over again that it cares about one thing and one thing only: The applause meter. The Fed wants to be loved and keep the party going."

"I find it quite incongruous that the markets fear the Fed will push rates up to contain something that everyone has agreed is not a problem. In my opinion, the better question is: Why is no one concerned about inflation? Why do the public at large, Wall Street and the bond market act like there's no inflation? My pet theory: Folks have done so well with their homes' appreciation and all the money-printing that, while prices are up, they've chosen to ignore inflation, as it's been 'good' to them. Thus, rising prices do not bother them."

"A change in psychology will occur when people start to get stung by the fact that their houses aren't going up in price. That will bring their focus to just how fast inflation is climbing. Of course, by that time, no one will really want the Fed to do anything about it because that would mean raising rates at a moment in time when housing prices are likely to be under pressure."

"However, I think a major inflection point is going to occur sometime in the not-too-distant future, when folks realize that the Fed is, in fact, done. Only after the Fed has made that unambiguously clear will it be possible for 'the next time down' to start. I expect the Fed to do so when the 'right' supporting data emerge. If that turns out to be the case, I think there will be quite a big rally in stocks, and an explosion in metals (and currencies). I intend to capture the latter and wait for the former, to take the other side of it."

Last time I read a CPI report, they jumped to the notion of "hey, if we exclude food and energy, it looks really good of only 0.1% increase."

And they proceed to say food and energy is really volatile so they aren't good indicators. Riiiight.

Better studies of 'cost of living' should be what people care about. Unfortunately that includes health coverage and that alone would make things look bad.
I really shouldn't listen to the financialsense news hour -- Mark Faber got me thinking about the possible need to have actual accounts in other countries, not just holdings in foreign securities/currency through American mechanisms (e.g., ETFs or everbank). Has anyone here seriously looked into this? It seems like it would be a huge hassle.
I remember reading back in Economics classes in college that the name of the game is to be ahead of the inflation curve, so people don't mind as long as they're in that position. People are finding themselves behind the inflation curve, or a case of where their income is rising slower than prices. This is the intended result by the Federal Reserve System. This is a way of confiscation of your wealth, through inflation AND interest rates.

Read about Probabilities of Recession.

"An inverted yield curve happens when long term rates fall below short term rates. The study looked at the 90 day T-bill versus the ten year bond. Essentially, every recession of the modern era has been preceded by an inverted yield curve of some depth and duration."
February 25, 2006
Off the Charts

On Wall Street, the Inflation View Is Rosier Than It Is on Main Street

CONSUMER prices in the United States are rising rapidly. Or maybe they are not.

The government's report this week showed that the Consumer Price Index rose 0.7 percent in January, bringing its 12-month gain to 4 percent. That is down a bit from the peaks of last fall, but the annual rate had not been 4 percent or more since 1991.

Did that bring despair to markets? Just the opposite. The talk among some Wall Street economists was that the Federal Reserve was now less likely to raise short-term interest rates again. The stock market rose on the news.

These days, Wall Street pays more attention to the core rate of inflation, which ignores food and energy prices. The core rate edged up just 0.2 percent in the month, leaving the annual gain at just 2.1 percent.

To ordinary people, that fascination with an index that ignores two of the most necessary parts of life may seem odd. The logic to it is that the volatility in energy prices will wash out, and that the core rate does a better job of showing the underlying trend.

Perhaps so, but year over year, the core rate has been lower than the overall gain in the C.P.I. for 39 consecutive months. That is the longest such stretch since the government started computing the core rate in the 1950's. Energy prices have been volatile, but the expected return to lower levels is not happening.

Another reason the inflation view from Main Street is less rosy than the one on Wall Street is the way a third necessity — housing — is measured in the index. The government estimates what rents would be on homes occupied by owners, and ignores sale prices. The 4.3 percent rise in housing costs over the last 12 months is higher than the rent increase of just 2.5 percent, largely because the cost of heating homes is up.

That is not the way the government used to do it. Until 1982, it considered the change in the price of houses, along with the level of interest rates. Greg Jensen of Bridgewater Associates, a money management firm, estimates that if the C.P.I. housing component were still computed the old way, both the core and the overall rate would be about 2 percentage points higher. How does 6 percent inflation sound?

Even the old method did not fully pick up the rising value of homes. The government's best house-price index, from the Office of Federal Housing Enterprise Oversight, will be out next week for the fourth quarter. But through the third quarter, it was up 12 percent year-over-year. Since the end of 1995, that index shows that home prices have doubled, while the C.P.I. shows housing costs are up by a third.

Rising home prices have made consumers feel more wealthy and given them more money to spend as mortgages are refinanced. But Wall Street looks at a Consumer Price Index that pays little attention to such rises, and says inflation is low. It is fun while it lasts.
Stephanie, Melody,

Nice to see you over here. Always appreciated your posts on Ben's other blog. ;-)

JL2, yes, that article's title states it in a nutshell. Been watching some CNBC today, and they're all living in their own little world. Of course, why would anyone willingly leave a fairy-tale life (i.e., "goldilocks economy").

Oh, interesting side note... the Street is interpreting increasing CAPEX as bullish. But what if most of that new investment is related to commodities (energy exploration & production, mining, etc.)?
"I really shouldn't listen to the financialsense news hour -- Mark Faber got me thinking about the possible need to have actual accounts in other countries, not just holdings in foreign securities/currency through American mechanisms (e.g., ETFs or everbank). Has anyone here seriously looked into this? It seems like it would be a huge hassle."

You bring up a good point. I'm not sure what faber's take on it is but my understanding is that your money held in an online bank is only as safe as the instiution(s) holding it for you (or their clearing house bank). In the event of a derivitives meltdown many if these huge banks and brokerages could be at risk. I would guess the same is true for an ETF. What if the brokerage house you hold it through goes under? Or their bank?

My knowledge of such things is limited but I have concerns about this myself and would really appreciate hearing from anyone else who knows more and could spell out the risks and possible solutions to this.
Foreign Bank Account info:
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