Morning Metrics

There aren't any today. At least not on the Econoday economic calendar.

So, uhm. Yeah.

Oh, wait. Federal Reserve Chairman Ben Bernanke has delivered remarks at the Banque de France Financial Stability Review Launch Event. You can read the text of the speech on the website of the Board of Governors of the Federal Reserve System. The title of the speech is "Global Imbalances: Links to Economic and Financial Stability", and - from my quick reading of the text - it is on the problems that can arise if some nations have a tight monetary policy and others have a loose monetary policy. He reflects on the breakdown in the US financial system, the way that breakdown was partially caused by an influx of capital from emerging markets (which in turn caused the financial breakdown to spread to those emerging markets). He then states that "...our collective challenge is to reshape the international monetary system to foster strong, sustainable growth and improve economic outcomes for all nations. Working together, we need to clarify and strengthen the rules of the game, with an eye toward creating an international system that more effectively supports the simultaneous pursuit of internal and external balance. To achieve a more balanced international system over time, countries with excessive and unsustainable trade surpluses will need to allow their exchange rates to better reflect market fundamentals and increase their efforts to substitute domestic demand for exports. At the same time, countries with large, persistent trade deficits must find ways to increase national saving, including putting fiscal policies on a more sustainable trajectory. In addition, to bolster our individual and collective ability to manage and productively invest capital inflows, we must continue to increase the efficiency, transparency, and resiliency of our national financial systems and to strengthen financial regulation and oversight."

I'm not certain that I agree with his conclusions - I'm much more Austrian school in my attitudes towards economic theory. I don't think that Chairman Bernanke is all that concerned with my lack of agreement, though. Particularly since I'm not an economist So rather than present my own opinions, I'll let John Maynard Keynes and F. A. Hayek battle out the pros and cons of their competing economic theories. Enjoy.

"Fear the Boom and Bust": A Hayek vs. Keynes Rap Anthem

Morning News

We start off the day with the Mortgage Bankers Association's Weekly Application Survey. Not because it's of vast important, mind you (except possibly to people who follow the financial sector), but because it is a bellwether of things to come. And, for the week ending 2/4, things aren't particularly coming. The market composite index declined a seasonally-adjusted 5.5% from the prior week, with the Refinance Index down 7.7% and the Purchase Index down 1.4%. The refinance share of mortgage activity fell to 66.6%, and the average interest rate for a 30-year fixed-rate mortgage rose 32 bps to 5.13%.

In other market driving news, Federal Reserve Chairman Ben Bernanke is going to be testifying before the House Budget committee today, starting at 10 AM. The Street will be watching his remarks closely, hoping for hints about future Fed policy.

In the "how did I miss that category", the Dodd-Frank financial reform law requires government agencies to go through their regulations and remove all references to credit ratings, working on the theory that part of the financial crisis was caused by over-reliance on those ratings. In response to this, the SEC has proposed to strip rating references from the Form S-3[1], replacing the former ratings requirement with alternative requirements. This particular plan is largely considered noncontroversial (although the large rating firms don't like it). What is more likely to be controversial is what impact this requirement to eliminate credit ratings from regulations will have on money market mutual funds. Currently, those funds are required to invest in high-grade securities, and removal of the credit ratings references has been opposed by the industry in the past. Now that Federal law requires it, nobody is quite sure what the SEC will do[2].

Looking to the Middle East, Credit Agricole bank is estimating that the current Egyptian crisis is costing the nation $310 million per day. The Egyptian government has not confirmed that specific number, but has acknowledged that it is causing their economy to suffer.

Anyone remember North Korea Crazy[3]? That little nutjob of a nation that got everyone's attention back in November by shelling Yeongpeong Island? Yeah, they're back in the news. Two days of talks ended in failure today when the North and South failed to set an agenda for the talks. Yes, that's right, it took them two days to work out that they couldn't even work out what they were going to talk about. The final collapse happened when the North Korean delegates all stood up and walked out of the conference.

Also, North Korea is accusing Japan of gearing up to reinvade Korea. This is probably just celebrating the fact that Kim Jong-un is now wearing his big-boy Furry Hat of Dictatorial Authority[4].

[1] "The Form what now?" The Form S-3 is a SEC form that (quoting from the SEC's website) "allows a company with less than $75 million in public float to register primary offerings of its securities". The company has to meet certain specific eligibility requirements, but if it qualifies it can go through a simplified registration process for an IPO.

[2] There is also some legitimate concern that this action will harm investor confidence in money market funds. Most investors like knowing that there is an objective standard for "high quality".

[3] "People See Me Shellin', They Hatin'" was a disappointment on the charts, easily pushed out of the top ten by Tunisia's "Takin' Bank", Yemen's "Steppin' Down (2013 Brutal Dictatorship Remix)" and Mubarak's "Don't Cry For Me, Egypt (You Know I'll Never Leave You)".

[4] Not a joke. Really. Follow the link.

Big Ben: "The Federal Government Is On An Unsustainable Fiscal Path"

"Big" Ben Bernanke spoke before the Senate Budget Committee, and he didn't really pull any punches. The full text of his prepared remarks are available on the Federal Reserve's web site. Here's some excepts, with comments, grouped more by category than by chronological order:

"The economic recovery that began a year and a half ago is continuing, although, to date, at a pace that has been insufficient to reduce the rate of unemployment significantly."

The economy is finally showing signs that things are recovering:

"More recently, however, we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold. In particular, real consumer spending rose at an annual rate of 2-1/2 percent in the third quarter of 2010, and the available indicators suggest that it likely expanded at a somewhat faster pace in the fourth quarter. Business investment in new equipment and software has grown robustly in recent quarters, albeit from a fairly low level, as firms replaced aging equipment and made investments that had been delayed during the downturn. However, the housing sector remains depressed, as the overhang of vacant houses continues to weigh heavily on both home prices and construction, and nonresidential construction is also quite weak. Overall, the pace of economic recovery seems likely to be moderately stronger in 2011 than it was in 2010."

Except for employment. That recovery hasn't really spread to employment, which could be a threat to the recovery:
"Although recent indicators of spending and production have generally been encouraging, conditions in the labor market have improved only modestly at best. After the loss of nearly 8-1/2 million jobs in 2008 and 2009, private payrolls expanded at an average of only about 100,000 per month in 2010--a pace barely enough to accommodate the normal increase in the labor force and, therefore, insufficient to materially reduce the unemployment rate.... Persistently high unemployment, by damping household income and confidence, could threaten the strength and sustainability of the recovery. Moreover, roughly 40 percent of the unemployed have been out of work for six months or more. Long-term unemployment not only imposes exceptional hardships on the jobless and their families, but it also erodes the skills of those workers and may inflict lasting damage on their employment and earnings prospects."

Unfortunately, we're not really expecting employment to recover really soon:

"Although it is likely that economic growth will pick up this year and that the unemployment rate will decline somewhat, progress toward the Federal Reserve's statutory objectives of maximum employment and stable prices is expected to remain slow. The projections submitted by Federal Open Market Committee (FOMC) participants in November showed that, notwithstanding forecasts of increased growth in 2011 and 2012, most participants expected the unemployment rate to be close to 8 percent two years from now. At this rate of improvement, it could take four to five more years for the job market to normalize fully."

Changing to a different subject, inflation really isn't a problem. Stop thinking it is:

"Recent data show consumer price inflation continuing to trend downward. For the 12 months ending in November, prices for personal consumption expenditures rose 1.0 percent, and inflation excluding the relatively volatile food and energy components--which tends to be a better gauge of underlying inflation trends--was only 0.8 percent, down from 1.7 percent a year earlier and from about 2-1/2 percent in 2007, the year before the recession began."

In fact, inflation probably will remain stable for a while:
"Despite the decline in inflation, long-run inflation expectations have remained stable; for example, the rate of inflation that households expect over the next 5 to 10 years, as measured by the Thompson Reuters/University of Michigan Surveys of Consumers, has remained in a narrow range over the past few years. With inflation expectations stable, and with levels of resource utilization expected to remain low, inflation is likely to be subdued for some time."

But, (returning to a previous topic) part of what's keeping inflation down is unemployment. And we're kind of concerned about that:

"The downward trend in inflation over the past few years is no surprise, given the low rates of resource utilization that have prevailed over that time. Indeed, as a result of the weak job market, wage growth has slowed along with inflation; over the 12 months ending in November, average hourly earnings have risen only 1.6 percent."

Also, did we mention that the simple fact that inflation is low could also be a serious problem? Because maybe we should mention that:

"FOMC participants also projected inflation to be at historically low levels for some time. Very low rates of inflation raise several concerns: First, very low inflation increases the risk that new adverse shocks could push the economy into deflation, that is, a situation involving ongoing declines in prices. Experience shows that deflation induced by economic slack can lead to extended periods of poor economic performance; indeed, even a significant perceived risk of deflation may lead firms to be more cautious about investment and hiring. Second, with short-term nominal interest rates already close to zero, declines in actual and expected inflation increase, respectively, both the real cost of servicing existing debt and the expected real cost of new borrowing. By raising effective debt burdens and by inhibiting new household spending and business investment, higher real borrowing costs create a further drag on growth. Finally, it is important to recognize that periods of very low inflation generally involve very slow growth in nominal wages and incomes as well as in prices. (I have already alluded to the recent deceleration in average hourly earnings.) Thus, in circumstances like those we face now, very low inflation or deflation does not necessarily imply any increase in household purchasing power. Rather, because of the associated deterioration in economic performance, very low inflation or deflation arising from economic slack is generally linked with reductions rather than gains in living standards."

Now, in terms of dealing with inflation and unemployment, we're kind of tapped out on resources:

"In a situation in which unemployment is high and expected to remain so and inflation is unusually low, the FOMC would normally respond by reducing its target for the federal funds rate. However, the Federal Reserve's target for the federal funds rate has been close to zero since December 2008, leaving essentially no scope for further reductions."

Changing gears, let's talk about this laughable collection of numbers you lot pass every year that you claim is an operating budget. A real budget balances income and outflows. What you pass just assumes that ever-increasing deficits are a mandatory part of the budgeting process. As a result, if you are under 40, by the time you retire this nation's "budget" will make the PIIGS nations look fiscally responsible.
"However, an important part of the federal budget deficit appears to be structural rather than cyclical; that is, the deficit is expected to remain unsustainably elevated even after economic conditions have returned to normal. For example, under the Congressional Budget Office's (CBO) so-called alternative fiscal scenario, which assumes that most of the tax cuts enacted in 2001 and 2003 are made permanent and that discretionary spending rises at the same rate as the gross domestic product (GDP), the deficit is projected to fall from its current level of about 9 percent of GDP to 5 percent of GDP by 2015, but then to rise to about 6-1/2 percent of GDP by the end of the decade. In subsequent years, the budget outlook is projected to deteriorate even more rapidly, as the aging of the population and continued growth in health spending boost federal outlays on entitlement programs. Under this scenario, federal debt held by the public is projected to reach 185 percent of the GDP by 2035, up from about 60 percent at the end of fiscal year 2010."

There has not yet been a serious attempt to fix this:
"It is widely understood that the federal government is on an unsustainable fiscal path. Yet, as a nation, we have done little to address this critical threat to our economy. Doing nothing will not be an option indefinitely; the longer we wait to act, the greater the risks and the more wrenching the inevitable changes to the budget will be."

We still have a chance not to be a third world country:
"By contrast, the prompt adoption of a credible program to reduce future deficits would not only enhance economic growth and stability in the long run, but could also yield substantial near-term benefits in terms of lower long-term interest rates and increased consumer and business confidence. Plans recently put forward by the President's National Commission on Fiscal Responsibility and Reform and other prominent groups provide useful starting points for a much-needed national conversation about our medium- and long-term fiscal situation."

Please, as our elected officials, act like grown-ups and govern. Make a hard choice or two.
" I hope that, in addressing our long-term fiscal challenges, the Congress will seek reforms to the government's tax policies and spending priorities that serve not only to reduce the deficit but also to enhance the long-term growth potential of our economy--for example, by encouraging investment in physical and human capital, by promoting research and development, by providing necessary public infrastructure, and by reducing disincentives to work and to save. We cannot grow out of our fiscal imbalances, but a more productive economy would ease the tradeoffs that we face."

Please note that, while my "explanatory comments" may be a little.. sarcastic, they really aren't inaccurate. If you don't believe me, read the transcript and see if I've taken anything out of context.

Farm Prices, Farm Costs, and the Money Supply

Internationally and here in the states, there are no economic measures due to be reported. None. Zip. Nada. There are a few items from yesterday,though.

The Agricultural Prices report was released yesterday, falling unperceived and uncared for on the ears of the market. The All Farm Products Index of Prices Received by Farmers was up 0.6% in December (up 19% for the year), with the Crop Index up 1.1% and the Livestock Index down 0.7%. Meanwhile, the December Index of Prices Paid for Commodities and Services, Interest, Taxes, and Farm Wage Rates[1], which tracks changes in the costs of farmers, was up 1.6% in December and 7.3% for the year. There's a lot of data in the report, showing that you can expect to continue to pay more for your food in 2011 than you did in 2010, but who cares? That's all irrelevant noise, wisely ignored by those who calculate inflation[2].

Does anyone remember "Big" Ben Bernanke's December 5th interview with 60 Minutes? If so, do you remember him saying this: "One myth that's out there is that what we're doing is printing money. We're not printing money. the amount of currency in circulation is not changing. The money supply is not changing in any significant way." Well, the Federal Reserve's Money Stock Measures report came out yesterday. It shows a 2.9% increase in M1 money supply[3] from October to November (a 9% increase from January), and a 0.4% increase in M2[4] from October to November (a 3.7% increase from January).

Technically, "Big" Ben is probably right. The Fed probably isn't working the presses and generating more physical currency. But, through the magic of fractional-reserve banking, the Fed doesn't have to print physical money to increase the money supply by 2.9% in one month.

Oh, and that 9% increase in M1 in 11 months? That's pretty much the reason people are concerned about inflation.

[1] This has the helpful acronym "PPITW".

[2] If it's not core to inflation, it does it really impact your pocketbook?

[3] That's currency in circulation plus traveler's checks in circulation plus demand deposits plus other checkable deposits.

[4] That's M1 plus savings deposits plus time deposits less than $100,000 plus money-market deposit accounts for individuals.

The Future's Are So Meh, You Don't Gotta Wear Shades

Right now, the domestic markets are still being driven by the news about the tax "compromise" from Monday. The news has helped drive Treasury prices down by 2%, pushing up yields. Why? Because this, combined with everyone's reaction to "Big" Ben Bernanke's comments on 60 Minutes, has bond traders worried about a long-term rise in the national debt.

Amusingly enough, the international markets are taking the improving yields as a good sign. According to Adam Cole[1], "the market is taking the rise in US yields as a positive for the dollar rather than a supply story. There are rising expectations for growth." As a result, the dollar is up against the euro and against gold.

China, which does not want to dominate the world thank you very much[2], does not agree. "For now, market attention is still on Europe and for the coming 6-12 months, it will not shift to the United States," said Li Daokui[3]. "But we should be clear in our minds that the fiscal situation in the United States is much worse than in Europe. In one or two years, when the European debt situation stabilizes, attention of financial markets will definitely shift to the United States. At that time, US Treasury bonds and the dollar will experience considerable declines."

Oh, apropos of nothing else, brace yourself for problems with your credit cards. Anonymous has declared war on MasterCard for blocking donations to WikiLeaks[4].

[1] The Global Head of Foreign Exchange Strategy for RBC Capital markets.
[2] "The international community should welcome and not fear China's peaceful development; help it and not hinder it; support it and not hold it back," says State Councilor Dai Bingguo. It doesn't have quite the same ring as "We will add your biological and technological distinctiveness to our own. Your culture will adapt to service us. Resistance is futile" or "all your base are belong to us", but it does carry a quiet air of understated menace.
[3] Director of the Center for China in the World Economy at Tsinghua University, and one of the academic members of the PBOC Monetary Policy Committee.
[4] A link that is probably not work safe, no matter where you are, now that Homeland Security is pushing to declare WikiLeaks a "terrorist website".

"We could raise interest rates in 15 minutes if we have to."

"Big" Ben Bernanke himself was on 60 Minutes today.



As the interview says, this is rare. Apparently, he decided to do it "because he believes his critics may not understand how much trouble the economy is in".

I suspect that is not a fair assessment. I don't think anyone has any real illusions about how much trouble the economy is in. It's probably more accurate to say that his critics do not agree with his solutions to the trouble the economy is in. But that's neither here nor there for the moment, because this is Big Ben's chance to shine. So watch the video, read the quotes, and revel in the rare interview provided by the Chairman of the Fed.

I'll have a few comments on the other side.

On unemployment:

"The unemployment rate is just not going down. Unemployment is just about the same as it was in mid-2009 when the economy started growing. So that's a major concern."

"At the rate we're going it could be 4-5 years before we are back to a more normal unemployment rate. Somewhere in the vicinity of 5 - 6 percent."

"More than 40% of the unemployed have been unemployed for 6 months or more, and that's unusually high."

On small businesses:

"A lot of small businesses are not seeking credit because their business is not doing well, because the economy is slow. Others are not qualifying for credit, maybe because the value of their property is going down. But some also can't meet the terms and conditions banks are setting."

On the subject of banks that took risks that caused the crisis not being willing to take risks to improve the economy:

"We want them [the banks] to take risks, but not excessive risks. We want to go happy medium. I think banks are back in the business of lending, but they have not yet come back to the level of confidence - overconfidence - that they had prior to the crisis. We want to have an appropriate balance."

On deflation:

"The other concern I should mention is that inflation is very very low, which you think is a good thing. And it normally is a good thing. But we are getting awfully close to the range where prices start falling."

On deflation:

"Well, I would say that this point, because the Fed is acting, I would say the risk is pretty low. But if the Fed did not act, then given how much inflation has come down since the beginning of the recession, I think it would be a more serious concern."

Is the $600,000,000 a bad thing?

"I know that some people think that. What I think they're doing is looking at some of the risks and uncertainties associated with doing this policy action. What I think they're not doing is looking at the risks of not acting."

What about the fear of inflation?

"This fear of inflation I think is way overstated. We've looked at it very very carefully. We've analyzed it every which way. One myth that's out there is that what we're doing is printing money. We're not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we're doing is lowering interest rates by buying Treasury securities, and by lowering interest rates we hope to stimulate the economy to grow faster. So the trick is to find the appropriate moment when to begin to unwind this policy."

Is inflation a lesser concern for the Fed?

"No. Absolutely not. What we're trying to do achieve a balance. We've been very very clear that we will not allow inflation to rise above 2% or less."

Can you react fast enough to keep inflation from getting out of control?

"We could raise interest rates in 15 minutes if we have to."

What are the odds we will fall back into recession?

"It doesn't seem likely that we'll have a double=dip recession.... Now that being said, I think a very high unemployment rate for a protracted period of time, which makes consumers, households less confident, more worried about the future - I think that's the primary source of risk that we might have another slowdown in the economy."

Is the recovery self-sustaining?

"It may not be. It's very close to the border. It takes about 2.5% growth just to keep unemployment stable, and that's about what we're getting. We're not very far from the level where the economy is not self-sustaining."

On deficit reduction:

"We need to pay close attention to the fact that we are recovering now. We don't want to take actions this year that will affect this year's spending and this year's taxes in a way that will hurt the recovery. That's important. But that doesn't stop us from thinking now about the long term structural budget deficit. We're looking at 10, 15, 20 years from now a situation where almost the Federal budget will be spent on Medicare, Medicaid, Social Security, and interest on the debt. There won't be any money left for the military or for any other services the government provides. We can only address those issues if we begin to think about them now."

On taxes:

"Tax code is very inefficient, both the personal tax code and the corporate tax code. By closing loopholes and lowering rates, you could increase the efficiency of the tax code and create more incentives for people to invest."

In short, there really aren't a lot of surprises here. He reiterates his stance on the economy, demonstrates his confidence that the Federal Reserve is up to the challenge of getting the US through the not-really-a-recession-any-more, and generally reminds everyone that whether you agree with his policies or not, he has reasons that seem good to himself and the rest of the Fed for the policies he sets. He really isn't just tossing a dart at a board and seeing what sticks.

I will say I was surprised by his comments on how long it will take to see unemployment rates come down. I mean, the Fed has been pretty candid about thinking they'll stay at 9.5% or so through 2011, but I did not expect to hear him say "4-5 years". I also did not expect (but I do agree with) his comments about the tax code.

Will this interview mollify his critics?

No.

Did you really expect it to?

No.

But it does do a good job of allowing him to make his case to the American people, and of reminding them that he didn't just get the job because he has a nice beard.

What's Happening Today? And Why Does Big Ben Hate China?

In terms of market-moving metrics, nothing. Of course, that doesn't mean that nothing's happening. If nothing else it's Expiration Friday, with everything that entails for the market.

Apparently the financial world is flipping out over China's decision to increase the reserve requirements for it's banks by 50 bps (that'll be 18% for their largest banks), effective 11/29. Why are they doing it? To suck excess cash out of the economy and try to reduce inflation. Bloomberg's got more details at http://www.bloomberg.com/news/2010-11-19/china-tells-banks-to-set-aside-larger-reserves-to-drain-cash-from-economy.html, if you want to see what's going on.

Also, Ben Bernanke spoke at the Sixth European Central Bank Central Banking Conference (redundant alliteration!) last night. The text of the speech can be found on the Fed's web page at http://www.federalreserve.gov/newsevents/speech/bernanke20101119b.htm, and the topic was "Emerging from the Crisis: Where Do We Stand?". In summary, he reviews what the European Central Banks and the Federal Reserve did over the past few years to try and prevent the end of Western Civilization as we know it, and then discusses what he sees as the lessons of the last two years:
* "Central banks and other financial regulators must be vigilant in monitoring financial markets and institutions for threats to systemic stability and diligent in taking steps to address such threats."
* "As the global financial system and national economies become increasingly complex and interdependent, novel policy challenges will continue to require innovative policy responses."
* "...in addressing financial crises, international cooperation can be very helpful; indeed, given the global integration of financial markets, such cooperation is essential."

That was one of his speeches. The other, "Rebalancing the Global Recovery" (http://www.federalreserve.gov/newsevents/speech/bernanke20101119a.htm), is the one that's been making the news for being an implicit slap against Chinese monetary policy. In it, he laments the apparent loss of common purpose (avoiding a global economic catastrophe) now that the worst of it is past, and he calls on policymakers around the world to "work together to achieve a mutually beneficial outcome - namely, a robust global economic expansion that is balanced, sustainable, and less prone to crises."

The implicit punch at China comes from several statements he makes about how "currency undervaluation by surplus countries ...inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals." His solution? "In the longer term, significantly greater flexibility in exchange rates to reflect market forces would be desirable and achievable. That flexibility would help facilitate global rebalancing and reduce the problems of policy spillovers that emerging market economies are confronting today."

In other words, if I understand his point correctly, "China needs to stop controlling its currency. It's not fair, and I'm going to sulk now."

He also advocates for the creation of an "international monetary system that more consistently aligns the interests of individual countries with the interests of the global economy as a whole." Because, yeah. The euro consistently aligned the interests of Greece with the interests of the European Union as a whole.