Thank you Barack Obama. Thank you Ben Bernanke. The Week In Review

For those who still question the two-tiered nature of this recovery, this week must have waylaid those doubts. No, it’s not about to collapse on itself, souffle fashion. That was predicted much earlier by a seer or two; we told our clients that was wrong. However, there is no denying the layered look.

The corporate world is lean and mean, healthy and profitable.

One individual played a key role in this US corporate transformation (although he’s modest about his accomplishment) and then another in the follow-up stock market performance we have witnessed recently. These two partnered up, working in concert; the first is Barrack Obama; the other is Ben Bernanke.

From the get go Obama scared the pants off of corporate America. We had that from CEO’s directly. His activist agenda (now mostly in tatters) meant that every new employee represented a threat. Thus the corporate world made changes long delayed, changes which did not postpone the need for new people but eliminated that need entirely, and permanently. Productivity! This goes a long way in explaining the stellar results in corporate earnings. And this explains in a sentence or two the so-called “jobless recovery.” It isn’t, but it seems that way to many.

Bernanke deserves credit too. Bernanke’s role is that he flooded the markets with liquidity. Nobody knew what to do with it all at first. Some went offshore because there didn’t seem to be much fun sticking around the house. And US bonds aren’t any better than a stick in the eye to a lot of folks, especially when there is the good risk of higher rates (lower prices) ahead. And Blue Chips seemed expensive. But Bernanke’s unending generosity eventually sparked an appetite for all kinds of things, including all kinds of stocks - that is, for companies which otherwise would have gone begging - money was so plentiful, might as well take a shot. That’s today’s reality. It’s that simple.

In the meantime, the rest of Americans - the other tier - are experiencing some pick up, some hint of recovery, or have just read about someone who has. Nothing stellar - Thursday’s Jobless Claims result showed that - but it’s catching on. And once the required retraining and relocation takes place, that adjustment forced on the American work force, the employment picture may look downright rosy.


Robert Craven

But For The Few of Us

It is easy now to sense US vigor. It wasn’t early October, 2010.

It’s easy now to understand that higher crude will cut into US GDP. It wasn’t late February.

It’s easy now to understand the Japanese will sculpt a recovery, and quickly, and that their stock market, after collapsing 14% at one point, Mar/15, was a buy. Any fool knows that. Any fool didn’t, Mar/15.

For the few of us who can set an anchor in the midst of a storm, those few of us can provide value to our clients.

And that is exactly what we do.


Robert Craven

Time To Sober Up - The Week In Review

The Street have come to understand that the US economy is at escape speed, all now looking in that direction. Sure enough, events this week illustrated that unemployment is still improving (Claims), that consumers are visiting department stores like crazy.

Mark Twain reminded us, “Whatever new thing a consensus coppers (colloquial for ‘bets against’) bet your money on that very card and do not be afraid.” Well, it’s not quite that easy, but you get the idea.

We were cheerleaders for the US economy when there was no one else in the stadium. Now the stadium is near capacity.

But those fans have yet to appreciate the impact of a new game rule - Mid Eastern tension and impact on US GDP by the way of crude prices.

Consider this week’s so-called Chain Store Sales result (which represent perhaps 10% of all retail sales but provides a pretty good litmus test). Results are reported Yr to Yr. Yesterday’s numbers seemed encouraging, folks buying like crazy. Now can any reasonable observer believe that results like these will continue with $5 gasoline? No.

The situation in the mid east will prove to be corrosive. This should not be a surprise. The surprise will be the extent of damage. Gas prices are heading higher than most even now appreciate.

Federal Reserve officials warn us that higher oil will not spark inflation. Thank you very much. That was never the real risk.

We have the worst, top-side impact of higher energy at 1% of GDP.


Robert Craven

Balancing Act

We’ve got the equivalent of an economic ledger, the debits and credits, and everybody wanting to own the identity of the bottom line before the next guy.

Our purpose is to discard the overflow of information, distill what is pertinent and present that to the client. We don’t offer graphs, charts or long-winded explanations, leaving these adornments to others.

The US economy is stronger than most expected it to be a few months ago. Clients were prepared for that fact, having the understanding of reality ahead of the market crowd. Then as recently as mid-Mar we predicted employment results which would again exceed estimates. That has been the result.

Now the crowd has accepted our premise. Once they do that they are slow to let go. While they were adjusting, we identified a threat or potential debit, something corrosive to our own view for vigor - that would be crude as tied to the Mid Easter revolution. That will detract from US GDP.

So we have this situation: We have more vigor than others expected and we have a potential threat that even now most have yet to acknowledge. That’s our ledger.

The average estimate for 2011 US GDP is now 3% and was set to go to maybe 3.75% by mid Q2 (although forecasters didn’t know that). IF that is, all is equal. All is not equal. Crude prices are to erase perhaps 1% from GDP, our worst case. That’s our balancing act.


Robert Craven

Observations At Stream Side - The Week Ahead

The economic release stream is scant this week; we will have a look at March non-manufacturing activity, courtesy of the Institute for Supply Management. This is a valuable read for vigor and employment in agriculture, mining, construction, transportation, communications, wholesale and retail trade. The release will likely exceed expectations.

But the key release by the way of market-moving horsepower is that for new unemployment Claims, for the Apr/2 week, released on Thursday. We told clients that the last figure would fall below expectations; that was the result. If that happens again the market crowd will be greatly cheered.

To understand market tension (and thus have a leg up on price discovery) one must understand crowd behavior. Key - a long time is needed for ideas to establish themselves in the crowd’s mind; once established, it takes just as long for these to be eradicated.

Observations at stream side provide a useful guide. Trout will take some food on the surface; not much however as it’s not worth the effort. They prefer to take nymphs near the bottom; that’s a lot easier and a lot smarter- there are no osprey (fish hawks) down there.

But occasionally a very large variety of stream fly will die and settle by the thousands on the surface. The salmon fly for example is a dozen times as big as the normal fly, a heck of a meal. But at first even though the salmon flies are drifting overhead in clear view of the trout the trout continue to feed as before. They see the salmon fly alright but that doesn’t register. They’re busy with the nymphs. Suddenly, and no one knows just when it will happen, the trout become “keyed in,” forsaking caution, shooting to the surface, slurping up as many salmon flies as they can.

The osprey’s shadow overhead or fly line carelessly slapped on the water - no matter, nothing will interrupt the orgy. Like members of any crowd, trout shed their individual identify and acquire that of the crowd itself. Reason, caution and judgement are exiled.

Soon the drift is over but the trout remain keyed in; they continue to mill near the surface long after, wasting energy, taking only little meals because the salmon fly have all drifted downstream.. Members of this crowd are looking in the wrong direction, once again missing the turn.

Thus, Q3, early Q4 our crowd had embraced the notion that the US economy was stuck. Ample evidence existed to the contrary, floating just overhead, but it was wasted on the crowd. Then something happened; suddenly the crowd abandoned their pattern, rejected their last notion, hanging it in effigy as if they were betrayed (there is nothing more vicious than a crowd which feels betrayed by the idol they once worshiped) Quickly, they accepted the new idol, that of economic expansion, especially that related to employment. Once again, they were all believers.

Another strong employment figure (Claims) will feed the frenzy. Yet the osprey, in the form of potentially much higher oil prices, glides just overhead.


Robert Craven

Those Pesky Offshore Events - The Week in Review

The US economic engine - just when she’s on the way to sparking on 6 of 8, one of those dog gone pesky offshore events threatens to throw a wrench into her works. Let’s take a look.

But first, let’s review the US economy. Our clients received a major heads up Q4. Forecasters were looking in the wrong direction. We predicted that when they sobered up, they would suddenly revise their US GDP estimates, much higher. This was the result. That pattern is closed.

Now to the present. This week was packed with key releases. We predicted strength in jobs, factory activity and vehicle sales. Factory activity was little changed, jobs cooperated nicely; Mar vehicles sales have yet to come in, this writing. We also predicted on Mar/24 after that day’s better than expected Claims print that the number of unemployment claimants would head even lower. Thursday’s number did just that.

Looking ahead , vigor will continue (aside from pesky offshore events) but key for our clients - most forecasters have finally caught on, depriving us of that major leg up which comes with early discovery.

Developments in the European Union appear to many to be a threat to the US economy but are not. A Special edition on this topic is in the works.

Developments in Japan have cooperated nicely with our anchor. Past a day or two of panic, markets there and in neighboring countries have recovered. There have been pipeline stoppages, delivery delays, but nothing not now priced in. A rescue package is near completion. Repatriation has so far been limited; Japan will instead issue bonds and although the Bank of Japan denies it, we expect them to at least partially finance this effort.

The yen is now at pre-quake levels vs the $. The horse is long gone from the barn. Even Warren Buffet agrees with us. It counted a great deal to understand this reality on Mar/14; it’s not worth much now. This pattern is closed.

Events tied to the tragedy will not throw a wrench in the works, will not act as a retardant on US GDP but will act as either a wash or modest spark. Eventually, observers will come to understand this reality.

Finally, we borrow copy from our Mar/4 post on the Mid East: During the weeks ahead we suggest investors and planners adhere to our anchor and acknowledge the glaring risk associated with this region. Course of least resistance for crude prices to remain higher over the intermediate term. It is foolish to believe otherwise.

Higher crude is not so much an inflation threat as a retardant and a powerful one if maintained through Q2. Clients can expect forecasters to begin to shave their US GDP forecasts, linked to this event. They just don’t know that yet.


Robert Craven

A “Jobless” Recovery? Don’t Think So. An Alert

Private employers, free from the threat of suffocation presented by Barack Obama’s earlier statist ways, have taken heart. The future is no longer one of threat piled upon threat. Given the sudden 180 at the White House, it just might be ok to take on a few new employees after all.

In today’s Mar Employment release we saw that private enterprise drove almost all the gains, adding 230M jobs after 240M in Feb. As one news service nearly shouted out, this is the first time private hiring topped 200M in back-to-back months since 2006.

The jobs market is not booming but is improving very nicely, generating sustained increases in private sector jobs.


Robert Craven

Employment, Spending and Our Pals at the Nursery

By most any measure the US economy is on a road of recovery. Yet you wouldn’t know that from some small business owners, including our nursery friends. They claim they haven’t been flattened by a customer rush for the roses. Yet we know that some discretionary spending is indeed booming, for example cruise bookings, or, nice jewelry which simply won’t stay on the shelf. What gives here?

Observers have for some time highlighted a so-called “two-tier recovery,” one which many claimed would collapse upon itself. It won’t but that’s not the point of this sketch.

Fact is that the top 10% of spenders happen to be those with a good deal of financial assets and are doing fine, in isolation from the rest. They’re buying jewelry and booking cruises. And the other 90%? Look no further than Barack Obama for the answer.

Corporations were scared witless by the administration’s statist agenda. This is no longer news. We have it from them directly. These potential employers had no guarantee that the election of Nov/2/10 would stop the damage, that repairs would be put in place. So 2008 and 2009 they made changes long delayed - not just improvements in productivity (common during the early stages of a recovery) but elimination of job slots permanently. Not knowing what would come next from an activist administration, one which never made a secret of its disdain for free enterprise, they had no choice. A new employee had become a ticking time bomb.

This explains why discretionary spending from the other 90% lags in this recovery and why plant and picture frame sales aren’t booming. We’ll get there, and now at a quicker pace given a new found affection for free enterprise at the White House.


Robert Craven

Home Sales Tank / Mid Eastern Craziness - The Week In Review

We do not recommend trades in this report, not equity, fixed income nor foreign exchange. Our job is to identify near - to- intermediate term change in the economy, those events which are not yet priced in. We isolate these for our clients and they take it from there.

All of us know now that the US economic engine is accelerating. This was not as obvious months ago when we highlighted this prospect for clients. Sure, it has not all fed down quite yet, we haven’t all felt it, but it’s there and on the way (short of the potential Mid East retardant). This, in spite of the administration’s bungling. So this is a good thing.

Yet how can we say this when this very week we saw figures related to housing which were in the tank? Well, it is known this sector is going nowhere; it’s priced in. That is why New Home sales Wed at a record low did not stir the markets. And one reason for that it that banks are more immune to this reality, having raised $300 bln in new equity in the last two years.

Of course homeowners are not immune, which is why forecasters figured last year that massive imbalances in housing would dampen spending ahead. This, along with their lack of appreciation of traction to be secured by Nov/2, led to their forecasting mega miss. We advised our clients that homeowners would spend anyway, which they did.

Let us move to offshore.

Fiscal events in Japan have concluded quickly this week. A rescue package is gaining critical mass, the currency has stabilized.

US firms have very little equity exposure to Japanese companies, a good thing. Next, there will be disruptions in supply lines for sure, but these are already priced in. There will be internal argument over funding for resuscitation also. We predict the Bank of Japan will support the effort but they adamantly deny it at the moment. For the US the event will amount to either a wash or modest spark.

Finally, we know the Mid East, not EU considerations provides the primary potential retardant to US growth. To restate the obvious, it is foolish at the moment to be constructive on energy prices. Events this week simply support our view for an expanding transformation, one painful and destructive in its youth yet constructive for all of us as it approaches middle age.

Robert Craven

Feb Existing Home Sales - far below expectations. An Alert

After their recovery the prior 6 months, existing home sales for Feb fell by 9.6% to 4.88MM, far below expectations. These sales are now 2.8% below the year ago level, almost 33% below the Sep/05 record high. No doubt because of a still bloated inventory, prices are 2.7% below their year ago levels.

We are going nowhere on home prices until the inventory-to-sales balance improves and the number of distressed properties is reduced.



Robert Craven

The Week Ahead

Events offshore will muscle our markets this week, perhaps eclipsing domestic considerations. The Mid East was reviewed earlier. We take a look at Japan, following our guide to the week’s data.

We have Feb Existing Home sales on Mon (expected to be lower), Feb New Home sales on Wed (expected to be higher). We have Feb Durable Orders on Wed. This key number reflects orders placed with manuf’s for delivery of hard goods. The number is expected to be up 1.5% but the risk is for something more. The unemployment Claims release on Thus is also key. The risk is that this release will cheer the market, falling below expectations. The third revision for Q4 ‘10 GDP is on Friday - ancient history. Also on Fri we have the Mar Univ of Mich sentiment figure, something to be ignored by planners and traders as it carries few leading characteristics.

Now to Japan. Anyone who bets against Japan does so at their peril.

True to the anchor set earlier we can expect the nuclear emergency to continue to diminish, we can expect the gov’t to rapidly set machinery in place for resuscitation, a process that will flatten St estimates. GDP may take a hit near term (maybe 1%) aggravated by a temporary national power shortage, but can be expected to surge, Q4. A major rescue package is nearing completion, including tax breaks. We expect the Bk of Japan to monetize the deficits needed to fund construction (although they currently deny such a step) and with that, pressure the yen lower, also a plus.

Production constraints associated with the crisis will be concentrated in Asia. Observers have highlighted supply considerations for US manufacturers; there will be little impact on our economy in this regard as Japan’s competitors move quickly to fill the gap. Look for headlines this week to cooperate with that view. This tragedy will provide an immediate spark to US industry. There will be some added pressure to energy prices as Japan will rely more on natural gas for power generation, at least for the near term. There will also be added pressure to materials prices - cement and re-bar come to mind.

We likely over-estimated the US price risk associated with repatriation but we do know accompanying yen strength would have retarded the Japanese recovery. Japan requested and received G-7 assistance in this regard. That potential crisis has passed. Look for further weakening, this currency.

Longer term implications for the US will be determined by the extent the growth of nuclear projects worldwide is impaired. From the Telegraph, we understand that the world has 442 reactors, with 65 under construction. “They generate 372 GW, covering 13.8pc of global electricity. The share is higher in the rich world: France 75pc, Belgium 52pc, Ukraine 47pc, Korea 35pc, Japan 29pc, the US 20pc, and the UK 18pc. In China it is just 2pc.” In the most general sense, output was expected to double over the next twenty years. A set back obviously translates back to conventional energy prices. Our view is that after some examination, nuclear will recover.

Robert Carven

Obama - Primary Retardant

In the old days folks, things were simple. Park at the Santa Fe depot and count the cars. Tour a shopping center parking lot. On a trip to Long Beach, check out port activity. That was about all there was to it. That’s all we needed to get a pretty darn good idea of consumer activity ahead. That’s worth 70% of the equation right there.

No more. As we noted the other day, you need a spook or two in the Mid East and half of Congress wired, or your without a leg up.

Well, we try to get by.

With all the noise and ruckus offshore, it is easy to forget that we’re sitting astride a US engine which was firing on 5 of 8 and is trying its best to go to 6 or 7. We’ve noted potential retardants, the Mid East key among these. But we had through ‘09 and ‘10 a very real retardant, nothing potential about it.

We were in school when Nixon convinced Burns to fire the economy on 9 of 8 cylinders, inflation be damned. Short of that event, never before has a correct sense of political reality so directly impacted economic strategy.

In fact, the single key hindrance to a recovery resides in the White House, or did. And don’t forget that Obama and his party are partly or wholly responsible for sparking the crisis in the first place (protected the twins from reform to buy black votes).

We stated in posts ahead of the Nov election that results would spark the economy. Forecasters missed this point completely; that is, the delivery of economic traction. As we predicted, both business and consumer were cheered by the result and then further cheered as the new majority in the House began quickly, more quickly than most suspected, to make repairs.

Obama’s education has represented a huge expense for all of us. He’s learned enough to act the right way to get re-elected. OK. To the extent he can refrain from further interference, the US economy will do just fine.


Robert Craven

Week in Review

It is our exercise to absorb the inflow of economic data, discard the chaff and then present the rest to our clients in distilled form. Thus, one Week in Review will generally suffice. Two are required for this week: yesterday’s summary of key data and how that may fit client anchors, and, today’s summary of impact, the myriad of events offshore.

Turmoil in the Mid East remains the key potential retardant to US growth. That consideration took a back seat this week given the tragedy in Japan.

The press continues to sensationalize, embellish and distort Japan's crisis. Reality remains that which we highlighted at the onset: 1) Japan will recover more quickly than most expect (despite excessive debt), 2) the nuclear situation and contagion will be limited and 3) influence on the US economy will be a wash, perhaps even positive. We also highlighted a wild card, a potential retardant tagged to this situation - Japanese repatriation and the selling of US assets. With that goes Yen strength, which if maintained over the inter term would retard the Japanese recovery. Today’s stunning G-7 activity reduces that possibility.

So back to the Mid East. A complete stoppage of crude deliveries from Libya was priced in at around 102 - 104. Thus, many look for a long term improvement in energy prices past this event and today’s “cease fire.” No. We have noted in several past posts why this time is different (see rt column). Contagion will continue to sweep the region, and with that, turmoil and threat of violence. On the plate is growing tension between Iran and Saudi Arabia. The potential of stoppage, or blockage of trade routes will remain a significant one. Eventually we know the spawning of consensual gov’t in this region is a plus, we’ll simply be a while in getting there.

We reminded our clients that when Bernanke implied that higher energy costs are a blip he was dead wrong, that when the IEA states that higher prices are here to stay, they are also wrong. But there is now a new potential element which may impact energy; that would be the demise of nuclear and the resultant increase in the demand for fossil products. We don’t think that will happen, but it’s now part of the equation.


Robert Craven

Japan - A Special

We noted in yesterday’s sketch that it is best for clients to expect more resiliency in recovery, not less, highlighting the Kobe disaster and response, as an example. No one agrees with us, not even the Japanese, the Nikkei off nearly 11% today. Still, if we are to error in our judgement, let it be in this direction. This is the course-of-least resistance, our view. This is to serve as an anchor for clients as the event continues to unfold. Best to anticipate these headlines as they surprise the rest.

We have already seen projected recovery-cost figures, something on the order of 1% of Japan’s GDP, perhaps to go to 1 ½ %. The Telegraph put this figure in context this am, noting such a package is less than a third, by scale, of the US fiscal stimulus plan. The two are also differentiated by impact - the US plan was a wash, a waste, a tragedy; Japan’s plan will impact immediately.

Resources for recovery will come from savings, both individual and now especially, corporate. The gov’t can spend like crazy because almost all its borrows comes from within Japan, from domestic savers, not from offshore. That’s how they will get away with it.

Next, the Bk of Japan’s response to the crisis was/is a perfect one, flooding the mkts with cash with no hesitation. They want to keep the yen down too so as not to discourage exports (a mistake made after the Kobe crisis - they waited too long).

Finally, to nuclear. The media cannot disguise their glee in reporting on this issue. Best to distance oneself from these lepers, tossing out the headlines.

The nuclear experts we have spoken to or listened to agree that the nuclear portion of this crisis is in the end likely to be more similar to Three Mile Island than to Chernobyl, Chernobyl being the equivalent of 1 million Three Mile Islands. Toxicity in the worst case would be contained in Japan (risk is “quite low” according to the World Health Org) and according to Columbia’s David Brenner even in that worst case - complete meltdown of the core(s) - exposure on the west coast of the US would be next to nothing.


Robert Craven

The Week Ahead

This week we have two key price numbers: Feb PPI on Wed and Feb CPI on Thursday. Also on Thursday we have Claims, Feb Ind Production and the Mar Philadelphia Fed manuf outlook survey. There are other releases but only these five carry potential mkt-moving hrsp. As we approach these numbers we will review each in more detail but all in, they are likely to indicate more vigor ahead, and building price pressures.


The tragedy in Japan remains a key near-term consideration. We suggest objectivity, which requires a distancing from the headlines.

Having the advantage of working closely with Japanese institutions, past years, we can confidently advise our clients to look for more rapid resuscitation than is now priced in.

Recall the Kobe quake of Jan/95 which killed 6400 people and caused damage observers put at 2% of GDP. Kobe is a key container port. Recovery was so fast that, according to Alan Wheatley of Real Clear World although Japan’s Ind Production fell 2.6% in Jan it rose 2.2% in Feb and again in Mar. GDP rose 3.4%, Q1 ‘95.

The “experts” put the Kobe recovery at a decade. But as we are reminded by the late George Horwich of Purdue, Kobe’s manufacturing was at 98% of pre-disaster levels in 15 months.

Japan not only has abundant resources, physical and human capital but the social and economic infrastructure to utilized resources in a hurry, including those contributed by the US and others. And - KEY - the current disaster is in a region far less populated and far less an economic factor than Kobe.

Finally, the word “meltdown” is a gift from heaven for the world press, very useful for bottom line purposes. It’s application is made by the media not only to single power units, but to the world industry. We must be cautious in this regard. Conventional wisdom has it that the renaissance in nuclear power is now finished. Perhaps not. The plants in question are very old.

We spoke this weekend with a nuclear engineer assigned to PGE’s Diablo Canyon nuclear plant. He advises that new back up systems likely would not have suffered the same fate - loss of power. He adds that the key now is to observe success +/- in Japan’s shut down process..

Caution is in order before leaping to oil and coal sectors; don’t write the obituary for nuclear just yet.


Robert Craven

The good 'ol days

We've had our differences with Greenspan over the years. He could not be more correct however in a recent article in International Finance. Gov’t “activism” he said, including fiscal stimulus, housing subsidies, and the slew of new regulations on the employer, are holding back the recovery. Companies’ hesitation to hire and invest, “can be explained by the shock of vastly greater government-created uncertainties....”

The only difference we have with Greenspan on this one, is timing. This paragraph fit perfectly pre-Nov/2. Since then, damage has been stopped and efforts made at resuscitation. Consumers have taken note. Employers have taken note. This event - Nov/2 - explains more than any other single factor the surprising growth of recent months.

Buy holy moly folks, in the good ‘ol days, all you had to know was economics. Now you’ve got to have half of Washington wired and a spook or two in the mid east or you can’t make strategy worth beans.


Robert Craven

Employment The Laggard

The US economy is progressing at a far better pace than most observers expected. Still, employment lags during this recovery.

Why? Shock treatment provided by Obama.

Potential employers took one look at Obama’s statist agenda and realized quickly that new employees were ticking time bombs. One could almost feel the collective corporate decision. Not just the health burden; witness the NLRB’s more aggressive attacks on the employer; then there is the notion of mandatory IRA’s for small employers. Or that in Jan/09 Obama signed the Lilly Ledbetter Fair Pay Act (S. 181). The new law will increase the number of pay discrimination claims, make them much more difficult to defend, and force employers to retain records relating to compensation decisions far longer than they have in the past.

In past reports we have quoted several CEO’s; it’s all the same - Obama scared the daylights out of these guys. The employment dept was closed. Naturally. Why in the world would anyone in his right mind want to take on a new employee with this guy at the helm?

Witness the recent sharp growth of shipping in the ports of LA and Long Beach, as reported in today's LA Times. Did trade employment numbers respond also? Only partially. As explained by one trade economist, “Trade employment numbers don’t reflect the growth in cargo movement because many companies have gotten more efficient......”

Companies made investments in efficiency, investments that were put off before. These planners were literally shocked into action.

Here is the answer to lagging employment.

Robert Craven

Commodity Price Inflation - A Closer Look

World commodity price inflation continues to monopolize the headlines. We spotlighted this topic in January. Food inflation (and income inequality, and high youth unemployment) has sparked much of the recent violence in the developing world. A closer look is in order.

We hear that price hikes in food and energy stocks, past 12 months, are impoverishing folks in lesser developed countries. Mother nature had a hand in much of this. We just saw the worst drought in Russia and the Black Sea region for 130 years, lasting long enough to damage winter planting as well as the summer harvest. This was compounded by late rains in Canada, Nina disruptions in Argentina, plus increased US grain acreage for ethanol, so on and so on. For example, the world’s stocks-to-use ratio for corn is nearing a 30-year low of 12.8pc, according to Rabobank.

Next, we know the developing world is booming, or was. So this - world demand - adds pressure. But these conditions have existed before, even in tandem. What else is there? Why the spike? Many blame Bernanke. Let’s see.

Take China as an example.

Chinese consumers find themselves paying exorbitant prices for food stuffs. Here is the money portion of the equation: Everybody in the world wants to invest in China. The Fed’s printing a ton of “hot money” (money which does not come from an increase in wealth or consumer demand, but from the press) and since there’s no need for it in the US a heck of a lot of it headed for China. Coming on top of China’s massive trade surplus (in dollars) these inflows provide a migraine to the Bk of China. Why? A cheaper dollar makes their yuan more expensive; their exports shrink. So the gov’t mops up these dollars from exporters and banks and prints yuan for each dollar purchased. That’s a heck of a lot of yuan thrown on the domestic market.

This is fine for the chosen policy of mercantilism but tough on Chinese consumers. Their currency is depreciated; they pay more for cooking oil and wheat while their export industry prospers. The Chinese gov’t is sacrificing the consumer on the alter of trade by choosing to import US monetary policy. Other countries who cannot resort to currency management are doling out more subsidies for energy and food. This behavior runs the risk of stalling the recovery in the developing world.

So yes, if you inflate the world’s money supply by $1.5 trl nowadays, you can be pretty sure that you’ll spark prices on those global, auction-priced goods priced in $’s, such as food and energy. In the meantime Bernanke plods along, battling the deflationary ghost.


Robert Craven

Thalidomide and the Fed

Until their plan to buy everything-under-the-sun the Fed provided (or extracted) liquidity mainly through an O/N market by the way of so-called “repos” or “reverse repos,” these with so-called registered dealers. The Fed fine-tuned with “Fed Funds” as the speedometer. FF’s is the rate prime banks charge each other for O/N money on which to make their required reserves good with their regulator. Some are flush, some aren’t. The hungrier banks are to make loans the more pressure on FF’s. If the Fed wants to slow things then they won’t meet the demand in that mkt; short term rates will spike, and in theory, economic activity will slow. If the Fed wants to be accommodative they supply more money to that market; banks take it as reserves and (Econ 101) the multiplier effect takes over.

Key here folks is that nothing was forced on the market, on the general interest rate environment; takers could come to or stay away from the trough, given demand or lack of in the economy. Longer-term rates ( 2 - 30 yrs) which impact all of us, were left to find their own level.

This worked fine until Q4 ‘08. Policy makers were desperate. Nothing in the medical cabinet would impact this new pathogen. Thus massive Fed intervention - no longer just short term operations, but buying long treasuries and mortgage paper, QE 1 (12/08 - 3/10) - was meant to 1) prevent a world meltdown and then 2) fire a recovery with lower rates. The meltdown was prevented. No one knew the side effects of this kind of medicine however.

Now there is no crisis but they’re at it again. We all know that Bernanke decided on the second major dose - QE 2, Nov ‘10 and plans to continue that medication to Q3 ‘11. Bernanke is now out of his league; if there is a Oath of Hippocrates for central bankers he hasn’t taken it.

Instead of a central banker he has become a government planner. QE2 is fraught with danger. His intervention is a useless as Obama’s attempt at gov’t planning, that which delayed the recovery. Bernanke is providing money which is not needed or wanted, except by the gov’t, banana republic style (The fed owns more Treasuries now than the Bank of China.) The US economy in not in need of liquidity.

The Fed’s program is meant to 1) feed the gov’t and to 2) feed the home market, a repeat mistake. It only penalizes the prudent - savers who would otherwise put their savings to more productive uses. This provides a distortion as these lower rates are purely artificial, driven by money created out of thin air. The Fed’s buying spree could create the very bubbles which brought us here in the first place. At the very least it is creating malformations on the US economic body.


Robert Craven

A SOUFFLE?

A growing chorus of observers sense a two-tiered recovery, one which they maintain is fragile and will eventually collapse on itself. Let’s take a look.

These observers admit that yes, the Dow is up, banking is cooking, corporations in general are more efficient than ever and cash rich to boot and that yes, manufacturing is actually booming. But these same folk claim that only 10% of the population - the moneyed class - have prospered. They maintain that’s not enough, thus this recovery is not sustainable. What is needed? Correct - government investment.

Reflect a moment folks: For two years Obama took water from one end of the pool and put it in the other, expecting something to happen. That was gov’t “investment.”

Then Nov/2 came along. We could predict ahead of that event that the consumer would be cheered. This was the result. Consumer activity, Q4 and so far Q1 has flattened estimates. We never claimed that the economy would catch fire, only that the St consensus was dead wrong about the consumer.

What did these economists miss? Half of them are fresh out of some Ivy League place where apparently all they learn about is ivy; not knowing any better they listened to consumer surveys, almost always a mistake. Next, even the seasoned forecasters did not account for economic traction obtained from Nov/2; they did not understand that 1) damage would be stopped pronto and 2) steps quickly taken for repair. Finally, they misjudged the average spender. Huge housing imbalances did not prove the hindrance to spending that they reckoned on. After all, most Americans have a job.

It’s very easy in this business to cherry-pick results to fit one’s forecast. We must remain sober in that respect. And in our sobriety we can say that the recovery ahead will not be V shaped for some and L shaped for most others. All will begin to prosper.

This recovery will not suffer the fate of the one and only souffle we ever made.



Robert Craven