Move at the Pace of an Injured Snail

 

shutterstock_76996180Pretty much everyone in the world wants the Federal Reserve to begin its “rate liftoff.” September is the latest target date for this market consensus. But permit me one dissenting question: Are you sure?

Or as the saying goes: Be careful what you wish for.

Take a look at a bunch of forward-looking, inflation-sensitive market indicators. They’re flashing deflation, not inflation. In the past year or so, gold has dropped from $1,300 to $1,100, spot commodities have fallen 16 percent on the CRB index and commodity futures are off 22 percent. Of course, oil has plunged to $42 a barrel, which amounts to a 56 percent price drop.

A 20 percent rise in the dollar has completely erased inflation fears. Economist Michael Darda calls it a de facto tightening. The end of QE and the expectation of higher future rates are behind the King Dollar move. Inflation expectations have been crushed.

So normally, with a rising dollar and all these commodity declines, the Fed would be thinking about lower rates and easier money.

But there’s more. In the Treasury bond market the yield curve has flattened. Anticipating a couple of Fed rate hikes, 2-year Treasury paper has bumped up about 30 basis points over the past year, while the yield of the 10-year note has dropped 20 basis points. It’s not an inverted curve, where short rates move higher than long rates — so there’s no recession forecast. But as investor Brian Kelly pointed out many weeks ago, if Fed rate hiking is accompanied by a drop in bond yields, we’ll have another deflationary signal.

In fact, the so-called Treasury break-even inflation spread (the difference between the market rate, which is about 2.2 percent, and the inflation-protected rate, which is only 56 basis points) has actually fallen 50 basis points over the past year. Indeed it should. The year-to-year change in consumer prices is flat. So is the change in the consumer price deflator, something the Fed watches carefully.

Just last week import prices registered a 10.4 percent decline, another consequence of the nearly 20 percent increase in King Dollar. Meanwhile, producer prices in July fell by nearly 1 percent. If you use the old PPI measure for finished goods, these prices have dropped 2.6 percent.

And if you are a monetarist, the 12-month change in M2 is only 5.6 percent. With nominal GDP through the second quarter coming in at a meager 3.3 percent over the past year, the turnover (or velocity) of money is still falling.

Now to some extent, this is all statistical mumbo jumbo. But if you are a Fed watcher it’s important. Some people argue that the Fed should raise its target rate because we’ve had steady jobs growth and a low unemployment rate. Putting aside the validity of the U-3 unemployment rate (labor participation and employment/population ratios are abnormally low), the fact is that more people working doesn’t cause inflation. As Milton Friedman taught us years ago, inflation is a monetary phenomenon: too much money chasing too few goods, and a sinking currency.

Well, there’s not much money being created, nor are there many goods being produced. And that’s the message of inflation-sensitive market indicators. Price stability. What’s wrong with that?

True enough, we’ve had a zero Fed target for nearly seven years. It can’t go on forever, nor should it. At some point the largest economy in the world has to have a positive central bank target rate.

But for now I’m not persuaded by the “manhood” argument (or with respect to Fed chair Janet Yellen, “womanhood”). And as far as bubble fears are concerned, low money growth, low nominal GDP growth, low commodities and a flattening yield curve don’t suggest anything’s about to pop. There may be bubbles in certain asset sectors, but not overall.

Former Fed governor Wayne Angell, one of the authors of the commodity-price-rule approach to monetary policy, told me recently that even though commodity indicators are weak, it’s “time to test the water.” Well, OK. He’s a very smart guy and he was a sound-money Fed governor. So I guess I can live with a small (one-and-done) quarter-point rate hike. But I’ll finish where I began: Be careful what you wish for.

My hope: The Fed moves at the pace of an injured snail. Frankly I’m not even sure it should do that much.

Published in Economics
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  1. LunaticRex Inactive
    LunaticRex
    @LunaticRex

    I’m not good with that stuff. You made the mumbo jumbo at least understandable. Thanks.

    • #1
  2. Basil Fawlty Member
    Basil Fawlty
    @BasilFawlty

    It’s a good thing we don’t have any conservative savers out there who foolishly planned on earning a bit of interest on the money they saved for their retirement.

    • #2
  3. Dan Hanson Thatcher
    Dan Hanson
    @DanHanson

    Fiat interest rates are nothing less than price controls on capital. They mask or destroy the information required for the market to figure out the right mix of short-term and long-term investments and to price the risk of investing for future returns.

    We need to stop pretending that the smart people at the fed are competent to know what balances to strike and what interest rates should be. The result of their errors is gross misallocations of resources and a lagging economy – which they then use as justification for continuing to meddle with interest rates.

    • #3
  4. Ed G. Member
    Ed G.
    @EdG

    Basil Fawlty:It’s a good thing we don’t have any conservative savers out there who foolishly planned on earing a bit of interest on the money they saved for their retirement.

    You may not earn the interest, but hopefully you make up for it with stable or even slightly falling prices. Nothing wrong with that.

    • #4
  5. Muleskinner Member
    Muleskinner
    @Muleskinner

    Larry Kudlow: Take a look at a bunch of forward-looking, inflation-sensitive market indicators. They’re flashing deflation, not inflation. In the past year or so, gold has dropped from $1,300 to $1,100, spot commodities have fallen 16 percent on the CRB index and commodity futures are off 22 percent. Of course, oil has plunged to $42 a barrel, which amounts to a 56 percent price drop. A 20 percent rise in the dollar has completely erased inflation fears. Economist Michael Darda calls it a de facto tightening. The end of QE and the expectation of higher future rates are behind the King Dollar move. Inflation expectations have been crushed.

    On the other hand, you would expect a stronger dollar, given that a big part of the world’s economy is either doing their own QE or outright devaluing their currency. If I’m trying to buy gold with Euros or Yuan, I don’t the price falling. Some of the dollar’s strengthening is due to fed policy, but a lot of it isn’t.

    A lot of the commodity price drop isn’t deflation, it’s old fashioned supply and demand. There is a lot more oil in the world than there was a few years ago, and ag commodities now appear to be in abundant supply (except maybe chickens and eggs, due to bird flu, but still supply and demand), especially given that the EPA has reduced the ethanol mandate.

    • #5
  6. Douglas Inactive
    Douglas
    @Douglas

    Basil Fawlty:It’s a good thing we don’t have any conservative savers out there who foolishly planned on earing a bit of interest on the money they saved for their retirement.

    Oh, we’ve learned our lesson. Thrift is fo’ suckas. Gaming the debt game is where it’s at.

    Responsible fiscal policy, with responsible interest rate policies? What are you, a fool? Grab that fiat money while you can, homies.

    • #6
  7. Basil Fawlty Member
    Basil Fawlty
    @BasilFawlty

    Ed G.:

    Basil Fawlty:It’s a good thing we don’t have any conservative savers out there who foolishly planned on earning a bit of interest on the money they saved for their retirement.

    You may not earn the interest, but hopefully you make up for it with stable or even slightly falling prices. Nothing wrong with that.

    So saving money in the hope of earning income from it is a thing of the past?  And, as I recall, the only thing lower than the rate of inflation is the rate of interest paid on savings.  It’s a net loss for savers.  But a great deal for borrowers.

    • #7
  8. jetstream Inactive
    jetstream
    @jetstream

    Ed G.:

    Basil Fawlty:It’s a good thing we don’t have any conservative savers out there who foolishly planned on earing a bit of interest on the money they saved for their retirement.

    You may not earn the interest, but hopefully you make up for it with stable or even slightly falling prices. Nothing wrong with that.

    Deflation is a monster that cannot be allowed to get out of the dungeon. It won’t create the zombie apocalypse but it would come close.

    • #8
  9. jetstream Inactive
    jetstream
    @jetstream

    Basil Fawlty:

    Ed G.:

    Basil Fawlty:It’s a good thing we don’t have any conservative savers out there who foolishly planned on earning a bit of interest on the money they saved for their retirement.

    You may not earn the interest, but hopefully you make up for it with stable or even slightly falling prices. Nothing wrong with that.

    So saving money in the hope of earning income from it is a thing of the past? And, as I recall, the only thing lower than the rate of inflation is the rate of interest paid on savings. It’s a net loss for savers. But a great deal for borrowers.

    That’s not actually true. With deflation, money as an asset appreciates in value and physical assets lose value. That’s why deflation is a catalyst for holding money and not other assets.

    • #9
  10. John Penfold Member
    John Penfold
    @IWalton

    So Larry’s a Keynesian after all.    Small business and entrepreneurial activity is being crushed by government.   The Fed is monetizing the debt while favored banks and big corporations do well and small banks are crushed by Dodd Frank.   The stagnation and weakness is an indirect result of the Fed  by letting the Federal government spend more than it otherwise could.  It will come to an end, it’s that the Democrats want it to come to an end when the Republicans take over.  How will that happen?  If they really transform the tax and regulatory code there would be rapid growth at the bottom end of the economy that uses lots of credit.  The 4-500% increase in monetary base will begin to expand into the money supply, inflating the economy weakening the dollar and the Fed will have to tighten, the market will decline sharply, housing prices will retreat and the world will pile on the Republicans.  They’ll cave in.   If they don’t cave in, the higher interest rates will increase returns to  savings, which, with lower taxes, should grow and will allocate those savings to investments with  higher returns.   Higher savings reduces the amount we have to borrow from abroad yet foreign investment flows in strengthening the dollar and helping the Fed end inflation.  The economy recovers rapidly and Republicans are reelected.   Larry, Says law has not been repealed.

    • #10
  11. Basil Fawlty Member
    Basil Fawlty
    @BasilFawlty

    jetstream:

    Basil Fawlty:

    Ed G.:

    Basil Fawlty:It’s a good thing we don’t have any conservative savers out there who foolishly planned on earning a bit of interest on the money they saved for their retirement.

    You may not earn the interest, but hopefully you make up for it with stable or even slightly falling prices. Nothing wrong with that.

    So saving money in the hope of earning income from it is a thing of the past? And, as I recall, the only thing lower than the rate of inflation is the rate of interest paid on savings. It’s a net loss for savers. But a great deal for borrowers.

    That’s not actually true. With deflation, money as an asset appreciates in value and physical assets lose value. That’s why deflation is a catalyst for holding money and not other assets.

    Deflation may be good for savers, but inflation has been much more common and pronounced than deflation over recent years, no?  Except in the realm of football.

    • #11
  12. jetstream Inactive
    jetstream
    @jetstream

    Basil Fawlty:

    jetstream:

    Basil Fawlty:

    Ed G.:

    Basil Fawlty:It’s a good thing we don’t have any conservative savers out there who foolishly planned on earning a bit of interest on the money they saved for their retirement.

    You may not earn the interest, but hopefully you make up for it with stable or even slightly falling prices. Nothing wrong with that.

    So saving money in the hope of earning income from it is a thing of the past? And, as I recall, the only thing lower than the rate of inflation is the rate of interest paid on savings. It’s a net loss for savers. But a great deal for borrowers.

    That’s not actually true. With deflation, money as an asset appreciates in value and physical assets lose value. That’s why deflation is a catalyst for holding money and not other assets.

    Deflation may be good for savers, but inflation has been much more common and pronounced than deflation over recent years, no? Except in the realm of football.

    Real deflation would be a tragedy for everyone. If it gets aggressively started it will be gory. We got a sneak preview of the disaster deflation unleashes starting in 2008 with the housing market. Fortunately the Fed realized the serious errors of their tight money policies and adjusted at light speed adding 2.5 trillion dollars of liquidity to the economy.

    • #12
  13. Jules PA Inactive
    Jules PA
    @JulesPA

    I think that snail in the OP photo looks pretty healthy and uninjured–I’m just saying…

    Thanks for the post and the comments, which I read with interest.

    • #13
  14. Ed G. Member
    Ed G.
    @EdG

    jetstream:

    …..

    Real deflation would be a tragedy for everyone. If it gets aggressively started it will be gory. We got a sneak preview of the disaster deflation unleashes starting in 2008 with the housing market. Fortunately the Fed realized the serious errors of their tight money policies and adjusted at light speed adding 2.5 trillion dollars of liquidity to the economy.

    Except that we know the housing market of 2008 was artificially inflated and not “real”. What you call deflation I call returning to reality. I think it turns out that we didn’t like reality all that much so we put a stop to that correction right away. We lie under a thick blanket of distortions; uncovering ourselves will not be painless, but there will be some benefits along the way.

    I’m no economist, but I’m skeptical of the hyper fear of deflation. If there’s to be fear, both inflation and deflation should be feared equally. And of course we should fear hyper-anything whether it’s inflation or deflation, but a mild course in either direction is probably not much cause for concern. Otherwise, I’m skeptical that deflation has no natural breaks the way inflation has natural breaks. Economics can’t be practiced assuming that counter reactions don’t exist.

    • #14
  15. jetstream Inactive
    jetstream
    @jetstream

    I’m no economist, but I’m skeptical of the hyper fear of deflation

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    Edit: So the Fed’s balance sheet goes from 800 billion dollars to well over 3 trillion dollars in a few months, the economy is barely limping with no inflation. And there was no deflation .. thanks for the economic lesson.

    • #15
  16. Ed G. Member
    Ed G.
    @EdG

    jetstream:

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    How civil of you.

    What makes my lack of understanding obvious, skepticism of the notion that deflation must be a monster while inflation can be mild? Or is it something else I said?

    • #16
  17. jetstream Inactive
    jetstream
    @jetstream

    Ed G.:

    jetstream:

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    How civil of you.

    What makes my lack of understanding obvious, skepticism of the notion that deflation must be a monster while inflation can be mild? Or is it something else I said?

    Maybe you can expound on the relationship of the Fed’s balance sheet, the velocity of money and how it all means that there was no deflation starting in 2008.

    • #17
  18. Ed G. Member
    Ed G.
    @EdG

    jetstream:

    Ed G.:

    jetstream:

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    How civil of you.

    What makes my lack of understanding obvious, skepticism of the notion that deflation must be a monster while inflation can be mild? Or is it something else I said?

    Maybe you can expound on the relationship of the Fed’s balance sheet, the velocity of money and how it all means that there was no deflation starting in 2008.

    When did I make that claim?

    I do claim that the housing bubble was indeed a bubble; I assume there is a distinction to make between a bursting bubble (based largely on regulatory distortion) and “monster” or “real” deflation. If there is no such distinction then that’s all the more reason for my skepticism concerning some claims I’ve heard about deflation generally.

    • #18
  19. Ed G. Member
    Ed G.
    @EdG

    jetstream:I’m no economist, but I’m skeptical of the hyper fear of deflation

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    Edit: So the Fed’s balance sheet goes from 800 billion dollars to well over 3 trillion dollars in a few months, the economy is barely limping with no inflation. And there was no deflation .. thanks for the economic lesson.

    The edit doesn’t really help much because the part you quoted was general, not specifically related to the fed balance sheet in 2008. Perhaps you should have edited the first sentence instead of doubling down on the venom.

    • #19
  20. jetstream Inactive
    jetstream
    @jetstream

    Ed G.:

    jetstream:I’m no economist, but I’m skeptical of the hyper fear of deflation

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    Edit: So the Fed’s balance sheet goes from 800 billion dollars to well over 3 trillion dollars in a few months, the economy is barely limping with no inflation. And there was no deflation .. thanks for the economic lesson.

    The edit doesn’t really help much because the part you quoted was general, not specifically related to the fed balance sheet in 2008. Perhaps you should have edited the first sentence instead of doubling down on the venom.

    Before you start lecturing you should understand the subject. You clearly don’t understand deflation. The Great Depression was deflation.

    • #20
  21. Ed G. Member
    Ed G.
    @EdG

    jetstream:

    Ed G.:

    jetstream:I’m no economist, but I’m skeptical of the hyper fear of deflation

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    Edit: So the Fed’s balance sheet goes from 800 billion dollars to well over 3 trillion dollars in a few months, the economy is barely limping with no inflation. And there was no deflation .. thanks for the economic lesson.

    The edit doesn’t really help much because the part you quoted was general, not specifically related to the fed balance sheet in 2008. Perhaps you should have edited the first sentence instead of doubling down on the venom.

    Before you start lecturing you should understand the subject. You clearly don’t understand deflation. The Great Depression was deflation.

    I was not and am not lecturing. The venom is still not appropriate.

    • #21
  22. Basil Fawlty Member
    Basil Fawlty
    @BasilFawlty

    Ed G.:

    jetstream:

    Ed G.:

    jetstream:I’m no economist, but I’m skeptical of the hyper fear of deflation

    Yes it’s obvious that you lack an understanding of deflation and the markets.

    Edit: So the Fed’s balance sheet goes from 800 billion dollars to well over 3 trillion dollars in a few months, the economy is barely limping with no inflation. And there was no deflation .. thanks for the economic lesson.

    The edit doesn’t really help much because the part you quoted was general, not specifically related to the fed balance sheet in 2008. Perhaps you should have edited the first sentence instead of doubling down on the venom.

    Before you start lecturing you should understand the subject. You clearly don’t understand deflation. The Great Depression was deflation.

    I was not and am not lecturing. The venom is still not appropriate.

    You obviously don’t respect SCIENCE, even the dismal variety.

    • #22
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