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Corporations, Give Thanks - With 'Enemies' Like This, Who Needs Friends?
by Paul Kasriel of Northern Trust,
On November 23, the Bureau of Economic Analysis updated its analysis of U.S. corporate profits. After-tax corporate profits from current operations hit their highest level, $1.221 trillion, since the beginning of this data series, 1947:Q1. Paul Kasriel gives further analysis.
Commodity Prices: What is Likely Impact in the United States?
by Asha Bangalore of Northern Trust,
The S&P GSCI commodity index has moved up 11.3% from a year ago on November 19, 2010 (see Chart 1). The trade weighted dollar declined 1.2% from a year ago as of November 12, 2010. The immediate inference is that the extent of gains in the commodity price index is larger than the decline of the dollar. By implication, commodity price gains reflect more than the depreciation of the greenback.
Is Inflation Lurking Around the Corner?
by Asha Bangalore of Northern Trust,
An inflationary threat is not lurking and nor are the current readings of inflation at levels the Fed needs to fret about in the near term. The Fed has traditional tools (raise reserve requirements, raise the federal funds rate or undertake open market sales of securities) and a new instrument, raising the rate paid on excess reserves. The probability of delayed action to address rising prices is small and will occur only if unemployment continues at an unacceptably high level. Inflation hawks cannot support their contention that QE2 is tinder for future inflation.
I Wonder What Milton Friedman and Karl Drunner Would Say About Allan Meltzer
by Paul Kasriel of Northern Trust,
On November 9, I wrote a commentary entitled ''Quantitative Easing in the mid 1930s Appeared to be Successful''. In my commentary, I did not mention what happened to the U.S. unemployment rate as a variation on quantitative easing was taking place. So, let?s do this now.
I Am Shocked, Shocked that the QE2 is Akin to Printing Money and Public Debt Monetization!
by Paul Kasriel of Northern Trust,
Whenever the sum of Federal Reserve and commercial banking system credit increases, credit is being created out of thin air and debt is being monetized. The magnitude of the credit creation being contemplated by the Fed is not extraordinary in an historical context. It is not an extraordinary increase in credit creation given the current amount of resource underutilization in the U.S. economy. Being shocked by the implications of QE2 with respect to ?printing money? and the ?monetization of debt? would appear to be either nave or hypocritical.
They Just Don't Get It
by Paul Kasriel of Northern Trust,
Had the Fed said that QE2 would involve the purchase of $600 billion of Treasury bills rather than Treasury coupon securities, we could have avoided this phase of uninformed criticism of the policy. Of course, the chorus of critics would have complained that by the Fed purchasing bills rather than coupons it was not affecting the ?important? part of the yield curve.
The Quantitative Easing in the mid 1930s Appeared to have been Successful
by Paul Kasriel of Northern Trust,
There is much skepticism as to whether the Fed?s second round of quantitative easing, QE2, will be effective in stimulating the nominal demand for goods and services in the U.S. economy. Keying off Mark Twain?s aphorism that although history may not repeat, it often rhymes, perhaps we can get some guidance as to whether QE2 will be successful from the results of the quantitative easing that was initiated in the second half of 1933.
QE2 Is Likely to Be More Successful than QE1
by Paul Kasriel of Northern Trust,
The theory behind quantitative easing is that an increase in the quantity of combined central and commercial bank credit will lead to an increase in nominal aggregate spending on goods, services and assets. Indeed, the correlation coefficient between percentage changes in the annual average of combined Federal Reserve and commercial banking system credit and the percentage changes in nominal U.S. GDP from 1960 through 2006 is relatively high, at 0.62. This correlation coefficient is reduced to 0.49, however, when the period is extended through 2009. Northern Trust explains why.
A Refresher Before Fed's Announcement of Second Round of Quantitative Easing
by Asha Bangalore of Northern Trust,
The Federal Reserve is widely expected to announce the second round of quantitative easing after the Federal Open Market Committee meeting on November 4. The goal of QE2 will be to bring about an increase in real GDP above the tepid 2.0 percent pace reported for the third quarter, as well as bring down the 9.6 percent unemployment rate. The reputation of the Bernanke Fed largely rests on the success of this new policy. Northern Trust present charts of Treasury bond yields since 2007, with markers for major monetary policy events.
Employment is Main Focus of Fed Policy
by Asha Bangalore of Northern Trust,
The Fed is widely expected to announce the details of the second round of quantitative easing following its two-day meeting ending November 3. Advocates of QE2 expect lower interest rates to lift all interest-sensitive expenditures, including home purchases, mortgage refinances and business expenditures. In addition, bankers could be more likely to lend given paltry earnings from excess reserves and Treasury securities. Finally, the benefit of increased exports from a depreciation of the dollar may reflect in headline GDP.
The Effectiveness of QE2 Depends on Quantities, Not Interest Rates or Exchange Rates
by Paul Kasriel of Northern Trust,
The level of U.S Treasury security interest rates or the level of the U.S. dollar foreign-exchange rate are not the correct way to think about the prospective effectiveness of QE2. What transpires with respect to commercial bank credit will determine the effectiveness of QE2 in increasing aggregate demand for U.S. goods and services.
The Real Economic Cost of Government Is Spending - So, What Do You Want to Cut?
by Paul Kasriel of Northern Trust,
Because the private sector generally uses productive resources more efficiently than the government does due to competitive pressures, the economy's long-run potential real economic growth rate is hurt by increases in federal spending. The largest projected increase in spending by an order of magnitude over the next decade is for entitlement programs - Social Security, Medicare and Medicaid. Millions of baby boomers will become eligible for Social Security and Medicare benefits over the next 10 years. Northern Trust also discusses home sales, employment and leading economic indicators.
Ten Questions: USA vs. Japan
The combination of lackluster growth and disinflation in the U.S. has led to comparisons with Japan's dire experience following the collapse of asset prices in the 1990s. A frequent question is whether Japan's 'lost decade' will play out in the United States. The Q&A included in this commentary identifies similarities and differences between the experiences of the two countries, with an emphasis on the recovery path. It appears that the U.S. is unlikely to mimic the economic path of Japan in the 1990s.
Michael Boskin?s Summer of Economic History Amnesia
by Paul Kasriel of Northern Trust,
Michael Boskin, former chairman of the President?s Council of Economic Advisers under George H.W. Bush, argues in a recent editorial for the Wall Street Journal that the current economic recovery is so feeble because of economic policies pursued by the current presidential administration. There is another reason for the relative weakness in the first year of this current recovery, however: the unprecedented contraction in nominal and real bank credit in the post-WWII era.
I Renounce Monetarism (with apologies to Mr. Lippman of Pendant Publishing)
by Paul Kasriel of Northern Trust,
Monetarists such as Milton Friedman hold that the M2 money supply is a leading indicator of aggregate demand. Indeed, from 1960 through 1989, the price-adjusted M2 money supply had a relatively high correlation with real aggregate demand for goods and services. As charts presented in this commentary illustrate, however, from 1990 through the second quarter of 2010 the correlation between real M2 and real final sales of domestic product deteriorated dramatically.
Nitty Gritty Details of the Labor Market Make Headlines
by Asha Bangalore of Northern Trust,
The elevated 9.5 percent official unemployment rate and the broader 16.5 percent jobless rate highlight the dire status of the labor market even after four quarters of economic growth. Financial markets have yet to follow closely the report on job openings, however, which contains information each month about the total number of job openings, the pace of hiring and separations in the economy. Harvard economics professor Robert Barro discusses the implications of the job openings report in a recent article for the Wall Street Journal.
Why Hasn't the Stimulus Been More Stimulative?
by Paul Kasriel of Northern Trust,
The $790 billion stimulus package was supposed to put the economy firmly on a trajectory toward recovery. As one Obama administration economic advisor has said, however, the economy is still having trouble reaching 'escape velocity.' This is because fiscal policy must be accompanied by bank financing in order to stimulate aggregate demand. Otherwise, fiscal policy just reallocates total aggregate demand toward government spending and away from private spending. Policymakers should therefore concentrate more on invigorating bank credit if they want faster economic growth.
'Federal Debt and the Risk of a Fiscal Crisis' - Important Takeaway
by Asha Bangalore of Northern Trust,
U.S. government debt held has reached a level not seen since World War II. There will be consequences to this elevated level of public debt. In addition to the well-known outcomes of higher interest rates and the crowding out of private investment, at the extreme, high debt levels could trigger a sovereign debt crisis similar to the recent situation in Europe. Northern Trust presents charts of federal debt as a percentage of GDP, with projections extending to 2020.
Bank Credit ? One Month Does Not Make a Trend, But...
by Paul Kasriel of Northern Trust,
U.S. commercial bank total credit increased at an annualized rate of 8.3 percent in July. If this is the beginning of an upward trend in bank credit, then we can feel a lot more confident about the prospects of rising real GDP growth rates in 2011. Subsequently, if bank credit continues to grow on a sustained basis and aggregate demand growth starts to pick up in the first half of 2011, then the Fed would be expected to begin raising policy interest rates around mid-year.
The Fed Has Not Run Out of Options, As Yet
by Asha Bangalore of Northern Trust,
The worst of the financial crisis is history, but the U.S. economy is still struggling to establish self-sustained economic growth. There is an ongoing debate among economists and policy advisors as to what is the best course -- fiscal austerity or stimulus -- to restore financial and economic tranquility. Discussions about the Fed's options in the event of further weakening of economic conditions in a deflationary environment have also surfaced.
Deflation and Credit Crunch ? Possible Themes for Chairman Bernanke?s Testimony
by Asha Bangalore of Northern Trust,
Federal Reserve chairman Ben Bernanke is scheduled for his semi-annual testimony about the economy at the Senate Banking Committee on Wednesday, July 21. The U.S. economy is in the throes of an economic recovery but the risk of deflation has entered the picture. As of now financial accommodation from the Fed has resulted in excess reserves in the banking system and is not being converted to loans. The chairman's thoughts about the severe credit contraction should be the most important topic of the testimony, in addition to deflation.
Potholes in the Recovery Road ? Reduce Speed Ahead
by Paul Kasriel of Northern Trust,
The second-half GDP growth forecast has been lowered to 1.8 percent and Q4/Q4 GDP growth in 2011 will be 3.2 percent. This is a business cycle unlike any other in the post-war era. In prior cycles, as the Fed raised the funds rate, growth in bank credit slowed. In the current environment, even with the Fed holding the funds rate at less than 25 basis points, bank credit continues to contract. Thus, we are going to utter the six most dangerous words in economic forecasting: This time it might be different.
Time For a Proactive Approach to Replace Lament of 'Anti-business Stance'
by Asha Bangalore of Northern Trust,
A recent Washington Post article cites members of the Business Roundtable who claim that new financial regulations and health care legislation are creating an 'anti-business' environment. This allegation, however, is superficial. Irrespective of the political party in power, new financial regulation should have been anticipated following the global financial crisis. And health care legislation of some sort would have been part of the Congressional agenda in the near term, anyway, given projected health care costs in the medium and long term.
When It Comes to Increasing Aggregate Demand, What?s Fiscal Policy Without Monetary Policy?
by Paul Kasriel of Northern Trust,
In order for an increase in government spending to result in an increase in total aggregate demand, the government's spending needs to be financed by the central bank and the commercial banking systems. Although the Fed and the banking system have helped fiscal policy to stimulate total aggregate demand through a cumulative increase in Treasury borrowing of $1,455 billion, the help was not all that spectacular. No wonder the results of the recent fiscal stimulus program were something less than awe-inspiring with regard to increasing aggregate demand.
Recipe for a Lost Decade, or Two
by Paul Kasriel of Northern Trust,
There are legitimate concerns that the U.S. could catch the 'Japanese' disease and endure a lost decade in terms of normal economic growth. As has been the case in Japan, weak U.S. money and bank credit growth is occurring in the context of very low monetary policy interest rates. The private financial system is not transforming the inexpensive credit being offered it by the Fed into credit for the private nonfinancial sector of the U.S. economy. Until this transmission mechanism between the Fed and the economy gets mended, we are unlikely to experience potential economic growth.
Navigating Fears of the Bond Market
by James Pressler of Northern Trust,
The need to keep the bond market happy while implementing often far-reaching fiscal reforms is most acute across Europe, where the outlook is for weak real GDP growth into 2011 ? albeit with significant variations between countries. Conversely, the recoveries in Asia and in the Americas have effectively eliminated fears of sovereign defaults but now concerns over economic overheating will dominate. The U.S will eventually have to address its own public debt overhang, but for now is enjoying a temporary safe-haven status.
Airplane Musings - Part Deux
by Paul Kasriel of Northern Trust,
Although U.S. federal government spending continues to increase, the rate of growth in that spending has slowed enormously. In the 12 months ended May 2010, accumulated spending by the federal government totaled $3.437 trillion, just 2.6 percent higher than the 12-month accumulated total federal spending for May 2009. This is quite a deceleration in growth from the 15.3 percent registered for the 12 months ended 2009 vs. 2008, near the trough of the last recession.
An Evaluation of the Threat of Near-Term Inflation
by Asha Bangalore of Northern Trust,
There is plenty of room for the economy to grow before the Fed slams the monetary policy brakes. Inflation expectations have moved down to 195 basis points as of June 11, from a high of 245 basis points at market close on April 29. Meanwhile, the money supply is barely growing. The ballooning of the Fed's balance sheet has not translated into rising inflation expectations. And final retail sales grew only 1.4 percent in the first quarter.
"Missing Elements" of Mr. Laffer's Incomplete Story
by Asha Bangalore of Northern Trust,
Supply-side economist Arthur Laffer recounts his experience with the Reagan administration to illustrate his arguments about the positive impact of tax cuts on economic growth with in a piece for the June 7 Wall Street Journal. Laffer predicts dire economic consequences if the Bush tax cuts are allowed to expire at the close of 2010. If Laffer's thesis is correct, however, then why, for example, did the economy post noticeable growth after the tax increases of 1993? And why did the U.S. economy undergo such a weak period of economic expansion following the Bush tax cuts of 2001 and 2003?
All We Are Sayin' Is Give Free Markets A Chance
by Paul Kasriel of Northern Trust,
Before we can determine whether or notfree markets have failed, we must actually have free markets. Central banks currently create or destroy credit by by holding a key short-term interest rate below or above the unobservable free-market equilibrium. The Securities & Exchange Commission determines which credit rating agencies receive official 'approval.' Lastly, without their debt being implicitly guaranteed by the federal government, Fannie and Freddie would not have been able to have consistently fund themselves at interest rates below other financial institutions.
Gold: Early 1930s vs. Early 2010s
by Paul Kasriel of Northern Trust,
Some argue that gold will outperform general stocks in the early 2010s, as it did in the 1930s. If this is true, then it will be for entirely different reasons. Investors currently gravitate toward gold as a hedge against future inflation, or because of a loss of faith in the fiat currency. U.S. gold mining stocks were strong performers in the 1930s, by contrast, because the U.S. Treasury was guaranteeing gold miners a steady or rising price as production costs were falling.
Greece, Portugal and Spain Are the Least of Our Economic/Financial Challenges
The debt problems that Greece, Portugal and Spain are currently facing have undoubtedly had a negative effect on global financial markets, and will probably have some negative effect on global economic activity. Problems with these countries, however, will not derail the global economic recovery that is currently underway. The biggest threat to the continuation of the global economic recovery would be some policy mistake by the Chinese economic policymakers resulting in a rapid deflation of the Chinese real estate bubble, which, in turn, would reduce Chinese real GDP growth.
Financial Regulation - The New Landscape
by Asha Bangalore of Northern Trust,
The Senate passed a new financial reform bill on May 20, while the House passed its own version in December. The next step is a reconciliation of the two bills, which should be ready for the president's signature by July 4th. The bills contain elements that will affect consumer protection, systemic risk, ?too big to fail,? derivatives, bank regulation, the Federal Reserve, credit rating agencies and securitization, and represent the biggest overhaul of financial regulation since the 1930s.
A Strategic Proposal to Combat Strategic Residential Mortgage Defaults
by Paul Kasriel of Northern Trust,
More and more we are hearing that occupants of residential real estate with mortgages far in excess of the current market value of their properties are choosing to default on their mortgage agreements. Many of these borrowers have calculated that it would take many years for the value of their properties to rise back to the amount outstanding on their mortgages. One tactic for lenders to stop these strategic defaults may be to write down the principal on the mortgage outstanding to an amount closer to the current actual market value of the property.
Lessons from Argentina on the Outcomes of a Possible Greek Default
by Richard Thies of Northern Trust,
As a member of a currency union, Greece cannot pair a restructuring with a large currency devaluation, two things that have usually gone hand in hand. That alone is enough to conclude that a Greek default would be hugely different from anything we've witnessed. As Argentina's default demonstrated, as much as it may look like the International Monetary Fund or other countries such as Germany are pulling all the strings, the decision at the end of the day is in the hands of the country's government.
A Typical European Response To An Atypical European Problem
by Victoria Marklew of Northern Trust,
Markets heaved a sigh of relief this week after European Union officials announced their $1 trillion rescue plan to save the euro. European states, however, will still have to face medium-term problems concerning fiscal deficits and economic restructuring. Demands that Spain make a renewed commitment to fiscal austerity suggest a new level of cross-country intervention. And the big issue has been swept under the carpet: how to ensure prudent fiscal policy-making across the 16 members of a monetary alliance with strong national identities and prickly memories of past hostilities.
ECB Sterilization -Trichet's Maginot Line?
by Paul Kasriel of Northern Trust,
European Central Bank president Jean-Claude Trichet has stated that the ECB will drain by other means the amount of base money it creates through sovereign debt purchases. If Milton Friedman was correct that inflation is everywhere and always a monetary phenomenon, however, then Trichet need not worry about a sustained acceleration in euro area inflation given recent declines in euro area money and credit aggregates. Northern Trust also comments on the Federal Reserve's swap lines with other central banks, and a recent small business survey.
'Tis a Short-Term Panacea, More Challenges in Store
by Asha Bangalore of Northern Trust,
The colossal rescue package from Europe consists of coordinated contributions from euro area governments, the IMF, and an EU emergency fund, amounting to a sum total of ?750 billion ($955 billion). World markets have responded positively, and have moved to calmer waters compared to recent turbulent market sessions. It is only a short-term respite, however; markets are bound to get jumpy again. The industrialized world is awash with public debt at levels never before seen in peacetime.
Gold Prices ? Just the Facts (and other notes)
by Asha Bangalore of Northern Trust,
The gold bug is alive and kicking. The current gold price of $1169.50 is more than three times the long-term average of $320.10. Uncertain economic conditions and sovereign debt issues have modified the place of gold in portfolios. Self-sustaining economic growth in one or more of the G-7 nations is necessary to reverse the course of gold because the low interest rate environment yields poor returns on interest-bearing assets. Northern Trust also comments on gains in the housing market due to the impending expiration of the homebuyer tax credit.
Declines in Bank Loans - Write-Downs or Pay-Downs?
by Paul Kasriel of Northern Trust,
The record decline in commercial bank loans/leases the U.S. experienced in 2009 was dominated by pay-downs (payments on loans) rather than write-downs (reductions in recognized value). Pay-downs have negative implications for new aggregate demand whereas write-downs are irrelevant with regards to new aggregate demand. Declines in capital limit the ability of banks to create new credit. The continued contraction in commercial bank loan/lease balances is cause for caution with regards to near-term growth in economic activity.
It's Been a While
by Paul Kasriel of Northern Trust,
Inflation is forecast to be 1.7%, rather than 2.5% as in Northern's previous forecast. Lack of credit creation in the private sector will result in a muted recovery, with GDP growing 2.8% in 2010. They are are in agreement with the Federal Open Market Committee that ?economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.?
Federal Deficit Reduction - Growth Helps at the Margin
The Congressional Budget Office tell us that we cannot grow our way out of the long-term federal budget deficit. The acceleration in real and nominal economic growth the U.S. economy has experienced in the past two quarters, however, is helping to reduce the deficit in the short-term. When growth picks up, corporate profits and household income do too. Thus, tax revenues pick up, or at least do not contract as much, while expenditures such as unemployment insurance benefits and food stamps slow down, not to mention government capital injections into teetering financial institutions.
Interest Rates are Creeping Up
by Asha Bangalore of Northern Trust,
The Fed is on hold in the near term, with nearly all its emergency programs either closed or expired. The effective federal funds rate has moved up in recent weeks, to an average of 16 bps in March, as have yields on other Treasury securities. The upward trend of Treasury market yields places the Fed is a tight spot, because the objective of easy monetary policy is defeated if Treasury market yields continue to move up and raise the cost of credit. Northern Trust's best bet is that interest rates will decline somewhat in the weeks ahead as bearish economic news comes out.
Guess Hu's Coming to Dinner at the White House - Much Ado About Very Little?
by Asha Bangalore of Northern Trust,
Chinese President Hu Jintao will attend a summit in Washington, D.C. on April 12-13. His plans have set off speculation that the Chinese government is prepared to let the yuan appreciate versus the U.S. dollar. Some in Congress want to brand China as a currency manipulator and impose protectionist penalties against the country. Chinese central bank balance sheets from last year, however, do not suggest that China engaged in extraordinary foreign exchange intervention. Bangalore also comments on impending reflation, and the expiration of the home buyer tax credit.
Guide to Distortions of Payroll Numbers from Census-Related Hiring
by Asha Bangalore of Northern Trust,
The employment report for March will contain hiring related to data collection for the 2010 census. Hiring for the census should result in wide swings of headline payroll estimates during the March-September period. Hiring in the private sector will thus be the true indicator of whether labor demand improved in March, rather than the headline number. Year to date, private sector employment shows a significant improvement in the pace of declines versus a year ago. Bangalore also comments on the U.S. dollar's continued reserve currency status.
Central Banks in 2010 - The Cacophonous Sound of Exit Music
by Asha Bangalore of Northern Trust,
Recent developments suggest that the uncertainty of the past three years has left central banks skittish. Otherwise strong economies have been slow to normalize rates and central banks that are following inflation targets have been more willing to risk breaches than growth. The remainder of the year will be characterized by differing exit strategies and their intended and unintended consequences. As central banks around the world begin tightening before the Fed and the ECB, there will be further implications for global capital flows and exchange rates.
Macro Effects of Patient Protection and Affordable Care Act at 30,000 Feet
by Paul Kasriel of Northern Trust,
The macroeconomic effect of the Patient Protection and Affordable Care Act will depend on whether the $900 billion shift of resources from the private sector to the government over the next ten years it brings will adversely affect labor productivity and technical progress, and by how much. On one hand, PPACA could result in a healthier and more productive workforce. On the other hand, increased government spending associated with PPACA may also have been spent by the private sector on health care, only in a less efficient manner: in the emergency room rather than on preventative care.
Budget Deficits: The Challenge Ahead in a Picture
by Asha Bangalore of Northern Trust,
Congressional Budget Office projections indicate federal outlays as a percentage of GDP will consistently exceed revenues even after the peak in outlays associated with the financial crisis and the recession. The fundamentals of the economy offer little hope for strong performance in the years ahead. A graying population and associated social costs will continue to add to projected outlays. Bangalore also comments on January's record low in the inventory-sales ratio, indicating strengthening demand.
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