Sunday, May 24, 2015

2% Inflation Target Stupid


Today’s CPI Lesson: The Fed’s 2% Inflation Target Is Completely Stupid

by David Stockman • May 22, 2015

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The madness of the Fed’s pending 81 month run of zero interest rates comes down to an inflation subterfuge that has no logical or empirical grounding in real world economics. Essentially, the Keynesians who currently inhabit the Eccles Building have turned all of central banking’s anti-inflation history on its head, saying, instead, that there is not enough of it to create optimum economic growth and wealth; and, besides, the CPI is running below the 2% target—so prolonging the free money gravy train can’t do much harm.

Every part of that proposition is dead wrong. To wit, free money does immense harm by fueling rampant carry trade speculation; there is zero evidence that 2% inflation results in any more growth than 1% or even 0% inflation; and, as an empirical matter, there is plenty of inflation in the US economy and has been during the entire past 15 years of rampant money printing designed to stimulate more growth.

Still, real final sales in the US economy have grown at only a 1.8% rate since the year 2000, or by just half of the 3.5% rate recorded for the prior 46 years. But that downshift is not in any way attributable to inflation missing the allegedly optimum 2% target. In fact, during the last 15 years the CPI has increased at an average rate of exactly 2.18%.

So where’s the beef or rather the allegedly missing beef? Well, the monetary high priests hold that the PCE deflator, not the CPI, is the correct measure of inflation because it takes better account of changing consumer preferences or weighting shifts in the market basket of what people buy. That is, it captures their shifting to chicken, tuna or spam when they can’t afford steak.

Yet its hard to believe that the scant daylight shown in the chart below accounts for the drastic deterioration of economic growth during the last 15 years. In other words, we have had 2% inflation on the most commonly used measuring stick—-so what’s wrong with the ruler?

After all, even the Fed’s own preferred inflation ruler has clocked in at 1.84% per year since the year 2000.  Presumably no adult would argue that a shortfall of 16bps per year from the magic 2.0% target would account for the 50% plunge in real economic growth during the last decade and one-half.

And this gets us to today’s report on the April CPI. Normally, Fed heads prefer the PCE deflator less food and energy on the grounds that the later elements are too volatile to properly measure the actual inflation trend.  Alrighty then. The April index for people who prefer to starve and shiver in the dark came in at a 3.6% rate for the month and was 1.8% higher than last April.

Unless you are some kind of monetary monk counting bps of inflation on the head of a pin, therefore, you might say “mission accomplished”. Inflation is running close enough to the magic 2.0% threshold for government work.

But you would be wrong. Yellen issued another cloud of pettifoggery today and practically said that money market interest rates will be pinned to the zero bound for at least another three months. Worse still, our befuddled school marm said that the Fed’s monumental money printing campaign is working just swell, and that after the Q1 weather aberration, the US economy will reaccelerate along the Fed’s intended path toward full employment.

How was she so sure? Why, real consumer incomes have made a significant upward move in recent months, meaning, apparently, that households will be spending themselves silly any day now.

Say again. Did she say that after six years of stagnation, real wages have actually started growing again?

Well, yes they have if you deflate nominal wages by the year-over-year change in the CPI. Thus, during the year ending in April average weekly wages rose from $840 to $858, whereas the CPI came in at zero on a year over year basis.

So go knock yourself out with that $18 gain, said Yellen. Your paycheck is up by 2.1% in something called “real dollars”( if you can find a place that takes them).

Then again, last April the price of oil was $115 per barrel versus its $60 level today. And since that thundering collapse in the global oil patch accounts for all of the CPI deceleration from the prior year gain of 2.0%, the implication of the real wage pick-up theory is quite clear. Namely, that this will keep happening year after year—–so we get $30 oil by year-end 2015 and $15 oil in 2016!

Here’s the point. The Fed is always trumpeting the PCE deflator less food and energy when they want to chastise the gold bugs and hard money advocates and prove that massive money printing has not caused a worrisome flare-up of inflation.

Except now that their entire post-crisis money printing spree is being called into question by an economy that is visibly faltering, they have opportunistically seized on the real wage theme by using a CPI based calculation of real wages—–even though the 0% CPI reading is truly a transient consequence of the oil bust and will disappear from the numbers in a matter of months.

In fact, they have been favoring the PCE deflator less food and energy for most of this century because it conveniently clocked in at a slightly lower rate than the full PCE deflator. But since that gauge is no longer convenient, it is apparently being chucked overboard.

Even then, however, the difference is so small over time as to reveal an important truth. These folks are just playing stupid numbers games to justify a policy of massive intervention in the financial markets that makes them rulers of the economic universe. Can any rational person believe that there is any difference over a 15 year period between the PCE deflator at 1.96% per annum and the PCE deflator less food and energy at 1.72% per annum.

It’s all noise and rounding errors, as shown below. There is absolutely nothing in the inflation data that justifies the Fed’s virtual destruction of price discovery in the financial markets, and the massive fraud it has introduced into the American economy by purchasing $3.6 billion of government debt over the past 7 years with credits conjured out of nothing.

Indeed, this morning’s 1.8% year over-year gain in the CPI less food and energy was an inflection point. It’s virtually identical to the inflation rate that foodless and heatless households have experienced over the last 15 years; and it’s so close to 2.0% as to invalidate the Fed’s entire inflation targeting policy regime.

The truth is, there has been plenty of inflation during the current century, as Doug Short vivified in the charts below. Indeed, on all the basics that consume most of the weekly pay- or benefit-check for upwards of 80% of American households there has been inflation aplenty. Food and beverage prices, for example, have risen at a 2.7% annual rate since the year 2000.

Likewise, medical care costs have risen at a 3.8% annual rate; housing costs at a 2.5% annual rate; and heavens forbid if you had to absorb college tuition and fees: They have by rising at a 6.0% annual rate.

Indeed, the whole chart is a rebuke to the money printers. When stuff goes up by 40% or better during the course of a decade and one-half, it suggest that too little inflation is most definitely not the problem.

What is the problem is massive financial inflation. The value of corporate equities (at market) and total debt outstanding in the US economy has exploded from $7 trillion to $92 trillion since 1981. And that’s not because it morning again in America. Growth has stalled to a 1.1% rate since 2007, and real household income is barely at levels first achieved in 1989.

No, the financial economy has ballooned from 2X national income (its historic level) in 1981 to 5X today for one reason alone: Namely, owing to the massive borrowing spree and asset inflation generated by the Fed’s destruction of honest price discovery and discipline in the nation’s financial markets.

Stated differently, the $92 trillion number for equities and credit market debt shown below would be about $35 trillion under the traditional monetary regime that had supported steady growth of the US economy and household real incomes for nearly a century prior to 1971.

The US economy is thus imperiled by a $50-60 trillion financial bubble. Yet the Keynesian Klowns who inhabit the Eccles Building are still counting inflation bps on the head of a monetary pin.

Total Marketable Securities and GDP - Click to enlarge

Total Marketable Securities and GDP – Click to enlarge

Total Marketable Securities % of GDP - Click to enlarge

Total Marketable Securities % of GDP – Click to enlarge

Nice to See CDS Quotes (Credit Default Swaps) On

Nice to See CDS Quotes (Credit Default Swaps) On

Germany's Hyperinflation in 1923, the Great Depression, and Austerity Led to an "Ugly Deleveraging" and Hitler's Rise to Power (Chart, Ray Dalio Video)

Germany's Hyperinflation in 1923, the Great Depression, and Austerity Led to an "Ugly Deleveraging" and Hitler's Rise to Power (Chart, Ray Dalio Video)

Wednesday, May 20, 2015

Second Great Depression

Contra News and Views

For Caterpillar, This Is What The “Second Great Depression” Looks Like

by ZeroHedge • May 20, 2015

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According to the latest CAT retail sales data, Caterpillar has now reported an unprecedented 29 months of declining global retail sales, with the month of April seeing a 16% Y/Y collapse in China (after a 25% plunge in 2014 and a 20% plunge the year before), while Latin America just suffered an epic 44% Y/Y crash, the biggest going back to 2009, after a 28% drop the year before.

Or as far as the industrial and heavy equipment bellwether is concerned, the emerging markets (or BRICS) are in an unprecedented economic collapse.

To put Caterpillar’s ongoing second great depression in context, during the Great Financial Crisis, CAT suffered “only” 19 months of consecutive retail sales declines. As of April 2015, this number is now 29, and there is no hope in sight of seeing an annual rebounce any time soon.

Source: For Caterpillar, This Is What The “Second Great Depression” Looks Like | Zero Hedge

Bigger Perspective by Doug Short

S&P 500 Snapshot: The FOMC Mini-Drama Ends with Another Fractional Loss

May 20, 2015
by Doug Short

The S&P 500 sank to its modest -0.25% intraday low shortly after the opening bell. With no economic news on tap, the focus of the day would be the afternoon release of the FOMC minutes. Sure enough we got a typical 2 PM fast-money trade, with the index rising to its 0.32% intraday high (a record one at that). But the minutes contained nothing to sustain the rally. The 500 then sold off to its fractional -0.09% close.

The official yield on the 10-year note closed at 2.26%, down one bp from the previous close.

Here is a 15-minute chart of the past five sessions.

Volume was unremarkable.

A Perspective on Drawdowns

Here's a snapshot of selloffs since the 2009 trough.

Click to View
Click for a larger image

For a longer-term perspective, here is a charts base on daily closes since the all-time high prior to the Great Recession.

Click to View
Click for a larger image

A Major Test Coming Up?

A Major Test Coming Up?

How soon the crash?

Stocks and Bonds Are Due for a Generational Crash of 75%

oftwominds-Charles Hugh Smith by Charles Hugh Smith 

From the point of view of history, a reversion to generational lows is inevitable, and a valuation level around 50% of GDP for stocks is a fair target.

If we look back to 1981 valuations of stocks and bonds as a guide to valuations at the next generational low, we find stocks and bonds are due for a 75% drop. The Great Bull market in bonds and equities took off after 1981, and has run higher for 34 years (notwithstanding a spot of bother in 2000-02 and 2008-09).

Before credit bubbles became the New Normal, the stock market was valued at less than 50% of GDP. Now stocks are valued at over 200% of GDP, as are bonds. Together, the total securities valuation is over 400% of GDP:

Data courtesy of Doug Noland

The GDP (gross domestic product) of the U.S. was around $17 trillion in 2014. If valuations returned to pre-bubble levels of 50% of GDP, stocks would have to drop from $36 trillion to around $8 trillion--a decline of 75%.

Bonds would have to experience a similar decline to reach pre-credit-bubble levels.

A drop back to the rich valuations of 100% of GDP would require a decline of 50% from current levels. In other words, the S&P 500 would be around 1,000, not 2,000.

To provide some context for the extreme valuations of present -day stocks and bonds, I have shown what the stock and bond markets would be worth in current dollars if they had simply tracked inflation since 1981. According to the Bureau of Labor Statistics Inflation Calculator, $1 in 1981 is now worth $2.60 in 2014 dollars.

If stocks had risen only with official inflation, the S&P 500 would be worth 10% of its current valuation: $3.6 trillion versus $36 trillion.

The bond market (Treasury, corporate and Municipal bonds and agency securities) would be worth 15% of the bond market's current valuations.

Measuring the valuations of bonds and equities in terms of GDP bypasses the debate over inflation.GDP has risen smartly in the past 34 years, and so the expansion of securities at the same rate is to be expected--never mind what official inflation registers.

Measured in GDP, stocks and bonds have reached extremes that make no sense except as the result of an unprecedented global credit bubble. Credit bubbles have a history of not being as permanent and durable as those living in the peak of the bubble expect.

By any reasonable measure, the current credit-bubble boom in stocks and bonds is getting long in tooth after 34 years of relentless expansion, and the rise of securities to 400% of GDP is reaching extremes that are increasingly difficult to support, much less push higher.

From the point of view of history, a reversion to generational lows is inevitable, and a valuation level around 50% of GDP for stocks is a fair target. This implies a 75% decline in both stocks and bonds within the next decade, if not sooner. 

The “Junkie” Economy and Impotent Fed

Our "Junkie Economy" Will Soon Hit Rock Bottom

Submitted by Bill Bonner via Bonner & Partners

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Addicted to Debt

Yesterday, U.S. stocks continued their climb, with a 26-point step-up to yet another all-time high for the Dow. Treasurys, meanwhile, continued to sell off. The yield on the 10-year T-note – which moves in the opposite direction to prices – rose 8 basis points to 2.2%. This follows last week’s turbulent action in the bond market, which saw Treasury yields hit a six-month high.

We have our eye on the U.S. bond market. Prices have been going up – and yields have been going down – for 32 years. And as prices have risen to the highest levels ever recorded, so has the amount of debt.

It is as though the world couldn’t get enough of the stuff. It got to be like heroin: The more debt the world took on, the more it wanted… and the bigger the dose it needed to get a buzz on.

But after the 2008 credit crisis, it is as though the major developed economies are immune to the stuff.

The Fed, the Bank of England, the Bank of Japan, and now the European Central Bank, have been buying it on the street corners. In the largest quantities ever.

But nothing much happens. At least, not in the real economy.

Sooner or later (a phrase we can’t seem to avoid), the entire economy is bound to get the shakes.

But we don’t know when sooner, or later, will come.

If it comes now, it will be a source of great satisfaction here at the Diary. “Finally,” we will say to no one in particular. “We knew it couldn’t last!”

A Healthy End to the Bond Bull?

There is an alternative explanation for falling bond prices. Bond prices should fall, and yields should rise, when economic growth picks up. As economic growth rates speed up, wages tend to rise… and people open up their wallets. Demand starts to outstrip the supply of goods and services. This drives up consumer prices. And interest rates start to rise. As rates go up, that raises bond yields and drives down bond prices.

This would be a healthy end to the epic bull market in bonds. A robust economy would allow central banks to raise rates and still allow debts to be paid down.

But that is not what is happening. And it won’t happen. Junkies rarely go out and get a job... and gradually “taper off” their habit. No. They have to crash... hit bottom... and sink into such misery that they have no choice but to go cold turkey.

Now, major central banks are committed to QE and ZIRP forever. They have created an economy that is addicted to EZ money. It will have to be smashed to smithereens before the feds change their policies.

An Impotent Fed

As colleague Chris Hunter reported yesterday to paid-up Bonner & Partners subscribers in The B&P Briefing:

In April, industrial production fell for the fifth straight month. And in May, consumer sentiment fell to a seven-month low.

And now GDP growth is flat-lining… Following the 0.1% annualized growth rate in the first quarter, the Atlanta Fed’s “real-time” GDP Now forecasting model is predicting 0.7% growth for the second quarter.

The U.S. economy may not be in an official recession – often measured by two back-to-back quarters of negative GDP growth – but it’s not far off…

Oh, but what about the big boost the economy was supposed to get from lower oil prices? What happened to that? Didn’t happen. Americans didn’t spend their gasoline savings; they saved them instead.

After adjusting for inflation, the median household income is down 10% since 2000. So it’s no wonder most Americans aren’t feeling very expansive.

And now, the price of oil is going back up. After hitting a low of $44 in March, today a barrel of U.S. crude oil sells for just under $59.

That leaves the Fed’s “stimulus” just as impotent as it has been for the last six years.

Interest rates remain ultra low. But the real economy remains as flat and dull as a joint session of Congress.

And the markets shudder...

Tuesday, May 19, 2015

If you think housing is going to save us

Stockman's Corner

Chop, Chop, Choppin’ At The Fed’s Front Door

by David Stockman • May 19, 2015

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With apologies to Bob Dylan, its clear that the casino does believe that the Fed is the monetary equivalent of heaven’s front door. Ever since QE officially ended last October, the market has been chop, chop, choppin’ higher on the slightest hint that 78 months of free carry trade funding may not end after all. This latest run-up makes the ninth time since the original Bullard rip seven months ago.
^SPX Chart

^SPX data by YCharts

That the Fed and other central banks have unleashed the speculative furies is an unassailable and baleful reality. Yet  this morning’s instant 40-point Dow drop in response to the posting of “incoming” housing data that looked slightly optimistic at the headline level was unusually absurd. Indeed, that this short-lived (@ 45 minutes) “housing is back” story spooked the market with fear that the Fed might finally cut off the juice——well, that is a canary in the trading pits that’s worth noting.

What is going on here plain and simple is a one-sided game of chicken. The robo-traders and hedge fund buccaneers on Wall Street press the market higher on virtually no volume or conviction whenever macro-economic weakness presents itself, virtually daring the Fed to maintain is ultra-accommodative stance still longer.

At the same time, the utterly clueless posse of would be monetary central planners domiciled in the Eccles Building invent one new pretext after another to justify delay, which only encourages the gamblers to press their advantage still harder. We have now reached the point where the casino is literally calling the Fed’s bluff, but these academic scribblers and power-drunk apparatchiks don’t even seem to know it.

This condition is especially ironic because the school marm who currently presides claims to be engaging in an unprecedented level of “transparency” with regard to the Fed’s intentions. In fact, however, the Fed’s communications regarding the sign posts it is watching are not simply transparent; they are essentially a content-free blank slate.

Thus, we are at 5.4% unemployment. Despite its flaws as a metric of labor market conditions owing to 91 million adults not in the labor force as reckoned by the BLS, the U-3 rate is a tangible marker; and for decades it was considered tantamount to full employment for government purposes. But it’s no longer any guidepost at all. Its actually more like the proverbial goalpost that has been moved time and again—–in this instance by Fed speakers and post-meeting minutes.

Indeed, Yellen actually has 19 labor market guidposts on her dashboard, and is apparently watching all of them without any indication as to the weighting because she doesn’t know, either. The Fed chairman is just insouciantly making it up as she goes along, using a 40-year old macro-model that bears no resemblance whatsoever to current reality.

Its worse on the so-called price stability mandate because 2% inflation has become a pure rubber ducky. Fed speakers have so obfuscated the issue as to which measure they will use, and for what run-rate over which period of time—–that their inflation guidepost might as well be reduced to this: Look ma, no inflation!

So based on all of this transparent pettifoggery, the Fed has managed to communicate that even a tiny 25 bps June rate hike is off the table and possibly September too. However, upon this morning’s Census Bureau release, the robo traders were shocked by a housing starts number that was higher than expectations, but actually just a tiny wiggle in the sub-basement.

Shown below is what had the market sweating at the Fed’s front door——a three month moving average of housing starts that is still below the bottom of every recession since 1955!

But actually the head fake was even more pathetic. It turns out that the northeast region accounts for barely 15% of US housing starts, but contributed nearly two-thirds of the gain over last April. Stated differently, excluding the aberrant flare-up in northeast region starts last month—-which will surely be revised—there were 87,000 starts in the US this April compared to 84,000 last year.

Yes, a 3.7% gain from last year’s level, which was the third lowest April ever recorded in modern times, was enough to spook the machines. And the reason is straight forward: The “fundamentals” have been abolished and honest price discovery has been destroyed by 15 years of non-stop central bank manipulation of financial markets.

In fact, like all the other “fundamentals” the housing starts and residential investment trend-line has fallen off a cliff. At 3.0% of GDP it is 40% below the historic average and 50-70% below prior recovery highs.

So housing is down in the pits with all of the other important economic fundamentals. Since the turn of the century there have been no new breadwinner jobs; real household median incomes have fallen by nearly 5%; real net business investment is down by 20%; and labor hours consumed by the non-farm business sector have not risen appreciably in 15 years.

Why is the market at an all-time high, and why is the S&P trading at nearly 21X reported earnings? One simple reason: the casino gamblers will keep chop, chop choppin’ higher until they finally lose confidence that the Eccles building is heaven’s door to further riches.

It won’t be long, however, until they discover that the global economy has tumbled into an epic deflationary spiral, that the US economy has not decoupled from the worldwide recessionary tide, and that the Fed and the other central banks have shot their wad and are now powerless to reverse the bust.

Then the machines will sell, sell, sell. There will be no credible Fed speakers to stop them. Nor will the dip buyers materialize in late morning to take down the offers.