Daily Notes.
THE FEDERAL RESERVE
If the Federal Reserve believed its bullish prediction for future growth in GDP and Jobs, they would either hike rates soon, or position the market for rate hikes. But the Federal Reserve has practically begged to be understood on this matter, as having no intention at all, to hike rates soon. The Fed is fighting Deflation, as evidenced by zero net job growth in the US, in conjunction with soaring levels of Debt. While the credit markets may move interest rates, up or down quite violently in the next 6 months, the Fed will not—cannot—hike interest rates into the current economic environment.
THE INFLATION vs. DEFLATION DEBATE
When debates become too polarized a logical fallacy known as a False Dilemma begins to appear. Such is the case with the great Inflation vs. Deflation debate. Both sides now are over-committed, and have stopped listening to data which opposes their view. In my newsletter of 01 March 2004
( gregor.us ) I attempt to resolve the dispute. Building on the theme, therefore, that we remain in a Deflationary paradigm—inside of which Inflationary pressures are building, and breaking out—I am forecasting that the US economy is likely headed back into Recession here in 2004. The Deflationary forces of over-capacity, wage-deflation, and debt-service are pulling us downward. However, and this is key, the policy response from Washington will be a brand new round of reflationary measures. These measures will further the current distortions and imbalances, which give fright to the Inflation hawks. And yes, these measures will be inflationary. But the paradigm will not change.
TEXTBOOK-MEN OF THE WORLD, UNITE
Observers from Stephen Roach to the Economist Magazine are now calling for the Federal Reserve to raise interest rates, to fight the coming Inflation. If you recall your Econ. 101 and Paul Samuelson’s classic (heavy) text, Inflation is exclusively a monetary phenomenon—and is guaranteed to occur when the Money Supply is expanded too quickly, or too greatly. The Money Supply has exploded upward since 1995, and we are now seeing commodity price inflation. Therefore, Deflation is not
possible because, according to the textbook, Deflation is a contraction of the money supply accompanied by falling prices. According to the textbook.
The problem here is that history is littered with the dead bodies of those who shook a Textbook Theory at the Lions of Reality. The explosion upward in the money supply since 1995 has served only to exacerbate production capacity, and debt. Were the Fed to hike Stephen Roach’s recommended, single-shot, 200 basis points--bringing the Fed Funds rate from 1.00% to 3.00%--we would see crashes in the housing, stock and bond markets. Demand for all goods and services would sag. Bankruptcies and loan foreclosures would soar. Losses on outstanding debt would be massive, and would be taken/booked by the lenders. But hey: this would indeed contract the money supply, thus reducing the risk of future inflation.
Some choose death by fire. Some by ice.
SHORT RATES
While the yield on the US Ten Year Treasury has already made a big move down, to 3.75%, I see no reason why 3.00% cannot be broken by mid-Summer, if this economy goes back into Recession. Were that to happen, I conjecture that short rates might rise a touch, as money migrates further out the yield curve. Money Market fund investors might actually see their yields rise back towards 1.00%. And while I don’t expect such an effect to last long, this could be disruptive to short-interest rate plays, as the overall Yield Curve flattens, in a classic portent of economic woe.
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