Inflation, Growth and the Market

every time the fed "lowers rates" they - the fed are essentially printing money.

think of it this way ... every time interest rates go down, they add more $$$ into the pool.

another way to think of it is that all of the dollars out there are shares of "america the company" which has a total net value - there are some fixed number of total shares ... so, the fed comes along and "lowers interest rates" - which is really code for "issues more shares", when the total number of shares are increased, the value of each individual share is reduced - so, the shares or dollars that you held prior to the "interest rate cut" are now worth less - otherwise known as "dilution of shares".

all fiat currencies eventually go to 0.

Everybody who was complaining about the trade deficit should be jumping for joy. The lower dollar is great for exports. As Bob Brinker says, "While the govt says they are pro strong dollar, they are really quite happy the dollar is down because of the increase in these exports." The foreigners will also be coming over here buying our real estate which will help us get out of the housing slump. We are far from being in a bad position.

People always want to look at the negatives rather than seeing how they can make each different situation positive.

I have been buying and selling houses the last few years. Rather than whine and cry about how hard it is supposed to be now to sell houses, I have changed my focus to collecting rental properties which I can buy EXTREMELY cheap right now. Of course all those people who lost their houses need a place to live. In a few months when this blows over, I will be back to buying and selling.

Real estate mogul wannabe wrote:

In a few months when this blows over, I will be back to buying and selling.

"a few months" bullshit, you should be ashamed. You know its more like several years. Or at least you should.

I do agree there are SOME positives in a weak dollar enviroment, as you mentioned.

The bond market does not indicate people are worried about inflation.

I didn't click on your link. If it is the kind of garbage you posted, I am glad I didn't waste more of my time.

Yes, the fed should lower rates. The Fed's job is to keep the economy going while minimizing inflation. The latest job's report showed pathetic growth. Inflation is not that big of a worry right now. The fed needs to act to counter the credit problem and provide some liduity to the markets.

when you are talking about asset prices (that is stock and bond prices), you have to remember that a rate cut has two effects1) it makes money cheaper and it hopefully spurs demand, investment, all that good stuff that the fed hopes it does (but the hope is it does not elevate inflation - recall as long as things come from the demand side there is a trade off between unemployment and inflation)2) consider a simple pricing formula (the most simple in fact)consider a stock that pays an annual dividend DIV - the same every year and the last dividend was just paid, then the stocks price should beP = DIV/r (we'll assume it is risk free for simplicity) - where r is the one year interest rate and assume investors assume after interest rates are set they will remain unchagedwhen the fed cuts interest rates r goes down which means stock and bond prices should go up (this assumes that the rate cut was a surprise)SO when I say two effects I mean- most stocks have uncertain dividends (derived from earnings) so when the fed cuts rates - demand is expected to go up which means DIV are expected to increase which means prices should increase (easily seen from pricing formula)- the discount rate decrease and you get the pricing effect I mentioned in 2)now is it rational - well sort of - sometimes a surprise rate cut can mean that things are worse than investors thought and they take it as very bad news - they think dividends this gives them information that dividends will be lower than they though, more than enough to offset the decrease in r effector sometimes it means that they think the fed's strategy will work, growth will go up and there is the pricing effectit all depends on how investors interpret the new informationcertainly it can be rational

i think that is a bit of stretchthe bond markets may not be too concerned about inflation (although implied inflation rates are above 2%)but the fed is - although core inflation has hovered near 2% - headline inflation has been too high - the idea was that headline inflation is volatile and that they will track each other over time so core inflation (the less volatile measure) is the better measureHowever, for some time now headline inflation has deviated from core inflation and it does not seem to be reverting to core levels - this is a worry to the fed - if this split is permanent(are oil prices permnanently higher, how about food) then they want / need to consider thatbernanke has in fact mentioned thisinflation is a threat there is no doubt about that - it can be very damaging - see the us circa 1980 and once it gets high - it is painful to get it back under control

da truff wrote:

Yes, the fed should lower rates. The Fed's job is to keep the economy going while minimizing inflation. The latest job's report showed pathetic growth. Inflation is not that big of a worry right now. The fed needs to act to counter the credit problem and provide some liduity to the markets.

Higher oil prices act like a tax since we import more oil than we produce by a large margin. A large amount of money we use to buy oil leaves the US. An increase in oil prices has consistently not lead to much of an increase in core inflation. Higher oil prices lead to a constriction in the economic growth.

With higher oil prices and the crapfest in the housing market, it isn't very likely that we will see real problems with inflation in the near future.

There is always a fear that oil and food prices will seep into other parts of the economy but we haven't seen much of it yet.

Besisdes, it is plain silly to think the Fed has control of the price of oil. Oil is a global commodity.

I personally would not mind if oil prices stay high for awhile so we get some alternative fuels going that are more competitive. I hate being dependent on nations where a lot of the people hate us. It disgusts me that in the 1970s we didn't learn our lesson.

And a weak dollar isn't a bad thing right now. We need to start exporting more goods to keep the economy going since people have lost a lot of value in their homes they might decrease spending.

One thing that I always prefer to look at when assessing an economic slowdown is consumer well being. Obviously the first problem for consumers is the loss in the paper value of their homes as well as the credit crunch that has spread out from the sub prime mortgage crisis. This is then couples with the rise in oil prices and food costs leads to lower consumer disposable income that is available for consumers spending and savings. While the drop in the dollar is theoretically advantageous for our trade deficit the November data just published shows that the deficit is still widening at 9%. This is a huge long run problem for the economy and will be as big a drag on the overall economic well being of the country as inflation could be. My opinion that the data appears support is that oil prices are driving the increase in our imports. One of the major issues from a trade balance perspective that needs addressing is the growth of China's foreign reserve. As a country we need to finance our debt through bonds but eventually these countries are going to want higher and higher returns. One startling sign that a few people noticed is that China is now focusing on gaining a higher return from its reserves which could spell trouble for the US government as China is the largest financier of our debt. As far as the markets go I would start by looking at the credit crunch and how that has affected the major banks most of which will be giving earnings reports in the very near future most likely too big write downs. After the subprime write downs investors are struggling to put a value to many assets on the markets but as liquidity is increased I believe that many investors will see the bargains that are available following the recent downturn which should spark somewhat of a revival. The FED and its FMOC branch look committed helping the market through both its auctions and its well publicized rates which should ease the problem. One area that I would watch is that the full effects of a change on the funds rate is not felt throughout the economy for almost 5 quarters so they need to be careful to moderate both short term gains in the market and the medium run growth of the economy. If you have any amount of liquidity the next few months through the summer look to be a great value based investment opportunity both in the market and on the housing front.

Keep this in mind, the fed isn't your friend, and the Fed is no more "Federal" than "FederalExpress".

da truff wrote:

Yes, the fed should lower rates. The Fed's job is to keep the economy going while minimizing inflation. The latest job's report showed pathetic growth. Inflation is not that big of a worry right now. The fed needs to act to counter the credit problem and provide some liduity to the markets.

Not too bad of an analysis. I'd say the effect of the Federal Reserve's moves is a little quicker than 5 quarters.

Anyway, most anyone paying attention should expect the 4th quarter numbers to suck donkey d!ck. The first two quarters of 2008 should be very slow growth too.

I don't get this hate for the Federal Reserve that Ron Paul type people have these days. Granted, the Federal Reserve has made mistakes in the past. It isn't perfect but it is tough to do the job it does.

China and other Asian nations and Middle East nations own a lot of our debt. If they don't keep buying it, interest rates will rise. That will suck for anyone who wants to buy or sell a home.

We need to adopt pay as you go. This administration has spent way too much money that we do not have and increased the federal debt way too much.

there is a reason that higher oil prices hasn't led to increase in core inflation - it is included in the calculation of core inflationwhere in the world did I say the fed had control of the price of oil - they can have an affect on consumer demand which certainly has some impact on all prices - that is the whole idea behind the trade of unemployment and inflation

wsj type wrote:

all fiat currencies eventually go to 0.

I doubt whether you can prove that statement, but I would love to hear you try...

Unless you are going to rely for your "proof" on some claptrap equivalent to "in the long run, we are all dead" (e.g., becauset the sun will eventually go "red giant").

"there is a reason that higher oil prices hasn't led to increase in core inflation - it is included in the calculation of core inflation"

I believe you meant to type not included in the calculation of core inflation. The point I think the previous poster was trying to make is that oil prices have gone up say (I am making up the number since I don't feel like looking it up) 40% while prices for clothing and other goods haven't risen much at all. Many people had predicted that the higher oil prices would enter other sectors. That really hasn't happened outside the transportation sector, which should be expected. I haven't looked at the last report but the only major area in the past outside of food and energy was healthcare costs were rising quickly and I don't think that has much to do with the federal reserve.

This is exactly right. I get accused of being other people all the time. Someone ought to accuse you and me of being the same poster, because that is EXACTLY what I was going to say.

To many people look for trends and then try to get on the wave then. Problem is that by the time it's a trend, you've missed the best time to be in. Sooooo, what people SHOULD be doing is investing all the time. I just had a big chunk of money go into my investments yesterday. Woo Hoo! Cheap stock! Bob Brinker remains bullish. He's about the most right guy I've seen, if he says stay the course then I'm staying the course.

Where a weakening dollar hurts companies is in this case -- I have a client in Canada that produces yarn that they sell mostly in the US. When the Canadian dollar (the Looney) was much less than the US dollar, they were in the money. Now, they are really struggling. They could raise their prices, but then they might lose business forever. If they can ride it out, they will get to keep those US customers. It's a tough thing for them.

My hunch was right, the breadth of knowledge of the Letsrun posters seems to know no bounds, and I thank each of you for your thoughtful posts.

wsj type

"all fiat currencies eventually go to 0."

Yes, this is the ultimate fear for any currency holder, and the pictures of wheelbarrels full of German Marks can make anyone cringe. Alan Greenspan advocated back in the 1960's in a book entitled "Captitalism: The Unknown Ideal" for a return to the gold standard for just such a reason. However, the other side of the argument is illustrated by Ben Franklin when he first moved from Massachusets to Philidelphia in the 1720's. He found the economy absolutely stifled for a complete lack of currency and advocated for printing it, of course he was a printer. But in general, this raises another question I have been unable to solve, and beg your insight.

If you go to a gold standard, than the money supply could not increase any more than the increase of the supply of gold. For the simplicity of argument, let's incorrectly assume that there is no more gold to be mined, and we have a set and finite money supply. If the population increases at just 3% a year, with the supply of currency fixed, than the demand for that currency must increase, all else equal, which leads to deflation. Just to illustrate, if you house is worth 1000 ounces of gold, and gold gets more and more desirable, than in a few years you'd be happy to get less than a 1000 ounces of gold for it, since gold is more dear.

The problem with deflation is that it creates a larger real effective interest rate: what you pay in interest less the inflation, or in this case, the deflation rate. So if some budding capitalist needs funds to start his business, he will pay some interest rate, and it may be low, say 3%, but if deflation runs 3% (in line with the population increase), his real rate is 6%. So ideally, to eliminate any inflation or deflation bias, you need the supply of capital to increase at least with the population growth, all else equal. I would think, as man becomes more efficient, economic growth could increase at many multiples of the population growth, so the money supply would have to increase at a much larger rate, just to eliminate the inflation or deflation bias.

So, even with you fiat currency fears, what choice do we have? Fix the amount of currency, or back the currency to a fixed standard like gold, and suffer the effects of deflation and reduced economic growth, or take your chances with the government printing presses?

anEconomist

"P = DIV/r ....

when the fed cuts interest rates r goes down which means stock and bond prices should go up"

This is an excellent illustration, thank you. However, my dilemma is with r. The fed only controls short term interest rates, not medium nor long term; only the markets control the latter. If by decreasing short term interest rates the market smells inflation, than, if rational they would demand higher long term interest rates. Than, if you discount those future cash flows with the now higher long term interest rate, than that P goes down. I've checked, and those 30 year rates just don't seem to want to go up. So I guess the market either doesn't fear inflation, thinks it will be short-lived if it does spark up, or perhaps, as I conjectured, is irrational.

whatjob

" While the drop in the dollar is theoretically advantageous for our trade deficit the November data just published shows that the deficit is still widening at 9%. This is a huge long run problem for the economy and will be as big a drag on the overall economic well being of the country as inflation could be."

Again, another insightful post that just makes me ask more questions: do trade deficits matter? I am not sure that they do. Any country selling to us more than they are buying from us is pretty much taking an IOU in the terms of US dollars. The question is what do they do with them. It seems from all the news I've been seeing is they are investing those dollars here in America. They are taking huge stakes in our companies. So essentially, ownership of the corporations, real estate, and other American assets are being converted into foreign names. While most will have a guttural reaction to that, economically, does it matter? At least provided they keep the assets here in America and run them as well as they have run previously, I don't know if there's any major negative economic impact.

Thanks again, I am humbled by your scholarly replies.

Ayn Rand student Alan Greenspan is indeed a very bright guy. He got out at exactly the right time.

And now the shit will hit the fan. And Bernanke will be blamed for it. But it isn't his fault---the Fed simply cannot fix this problem; they are the problem.