Phony Recovery Poses Dilemma for the Fed

Schizophrenia still reigns at the Fed as policymakers attempt to head off an inflation that, statistically speaking, is almost nowhere to be found. In fact, inflation has fallen by more than half since 2007 if you measure it the way the Fed prefers, using a price index of personal consumption expenditures. What is the diligent monetarist supposed to do?  While some of the Fed governors see the glass as half-empty and want to keep interest rates low, their delusionally sunny colleagues want to tighten because they evidently believe all of the twaddle we’ve been reading about how the economy is in the throes of a strong recovery.  Consider the following headlines from Google’s business-news section yesterday afternoon: “Bets on Growth Buttress Stocks” (Wall Street Journal); “Oil Surges to 17-Month High on Signs of U.S. Economic Growth” (Bloomberg): and, “10-Year Yields Hits 4 Percent on Signs Economy Picking Up” (Reuters). To borrow a line from Goebbels, if the news media keep trying to mislead us with stories like these, eventually we will come to believe them.

Or will we?  It’s one thing for the Wall Street Journal et al. to get all stoked about the supposedly robust pace of the recovery.  After all, the Journal’s owner, Rupert Murdoch, didn’t get rich telling readers the world was going to hell in a hand basket. But just because Murdoch has chosen to be a cheerleader rather than risk circulation and advertising revenues by giving it to us straight, that doesn’t necessarily mean that we readers have to believe such bilge. Why should we, when there is no hard evidence of a recovery in the economic lives and businesses that we see, and hear about, all around us?

Behind the Headlines

Could the newspapers simply be misinterpreting the signs?  It would certainly seem that way. To take the headlines cited above, we see oil’s price surge as having absolutely nothing to do with a pick-up in demand. Rather, the push toward $90 a barrel represents speculative excesses in the futures markets, exacerbated by the reluctance of traders to take short positions.  How could they, when, on any given day, a terrorist with a missile launcher could cause the global price of crude to double instantly by scuttling a tanker in the Strait of Hormuz?   As for “bets on growth” pushing stocks higher, it is not bullish speculation that has been driving up shares for the last 13 months, but rather a vast excess of liquidity in the financial system.  As for the rise in T-Note yields to four percent, we seriously doubt this is being caused by competition from expansion-minded borrowers in the private sector;  rather, it comes from the rising apprehension among lenders that they will be repaid in a currency whose value looks all but certain to fall precipitously in the years ahead.

Meanwhile, if the central bankers truly believe that strong economic growth is about to trigger inflation, why do they continue to hold the federal funds rate near zero? The recovery story is a hoax, is why.

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  • Chris T. April 7, 2010, 1:12 am

    oh, oh photoradarscam, you are making the inflation argument, that could incite a debate again!

    Jason: “The Fed cannot keep buying bonds indefinitely.”

    Actually, they can. Would they, who knows? Should they, of course not.
    Question is, if they did, what would that do, but worse if they did not, what would the interest rates do?

    At a 5% rate across the full maturity structure on average, that would be about 650 billion dollars p.a., or ~ double what is incurred now.
    Applied to the current budget, it would consist of more deficit than revenue (never happened before, we are at maybe 55% revenue today).

    That 5% avg. is moderate, compared to other times, such as late 70s-82. We can’t afford a rate rise, period. Even new taxes wouldn’t help, because they would barely cover new expenditures:
    When we start the hot-phase of the Iran war this year (prob. before the Nov. certainly right after the terrorist attack on us by Iran [wonder if they will go for NYC again, or get creative]), things will get pricey quick, and the DOD funding explode yet again. Then there is healthcare, the new money going to students and on, and on.

    So, the Fed has plenty of incentives to help out…, and a soft-default is so much more attractive than a hard one.

  • Richard Landwirth April 6, 2010, 9:19 pm

    The reason crude is going up now…and when it went to $145, is the desire by traders and money managers for a safe haven-they know that gold is a no-go thanks to the “rig”-so crude, by default, serves the role of gold-they want diversification into tangibles–any tangibles-and crude is the deepest and most liquid market-it looks like we’re gonna repeat the run up to $145 followed by another collapse–and a holocaust in gold futures and gold equities…

  • FranSix April 6, 2010, 8:28 pm

    The advance in the oil price can be attributed to very few speculators wanting delivery. What are they going to do with it, except pile it up?

  • Robert April 6, 2010, 7:35 pm

    @ Gary Leibowitz: “The signs of recovery are real. Inventory is low, manufacturing is picking up, job gains are occurring. None of these things are delusional. ”

    – Ummm, inventory of what is low? Washers and Dryers? 95 inch TV’s?

    People are hunkering down on discretionary spending. Average usage life of a PC has gone from 27 months in 2002, to 36 months in 2009.

    Until consumer goods inventories get low enough that prices start climbing, low inventory data is a non-starter as a factor in the sustained recovery theory (IMHO)

    There are tankers sitting at port all over the world filled with crude oil with nowhere to take it. There are ships at port in Hong Kong and Singapore filled with chinese manufactured consumer goods (toys, kitchen utensils, and other knick knacks) with nowhere to take them.

    And about those employment numbers- high paying private sector jobs that have been lost and replaced with entry level government sector jobs like Census takers also does not strengthen the argument for sustained economic recovery- it is possible for the unemployment rate to start creeping down without a corresponding increase in GDP if real incomes keep declining since the “new jobs” are all entry level, while the “lost jobs” all paid at the median per capita income or better…

    “The problem is that we are starting at such high saturation of debt and insolvency that it is virtually impossible to “pretend” the new mountain of debt can ever be repaid.”

    – We can certainly agree on this point, but the only way this scenario works itself out in a postive fashion is if this becomes the FIRST TIME IN HUMAN HISTORY that private debt was converted to sovereign debt without a corresponding meltdown in the economy, the currency system, or both…

    I don’t like those odds at all.

  • JPM April 6, 2010, 7:12 pm

    I’d like to add to what Gary has said that the ISM-Index
    is at the highest of the last five years, so that the money
    tsunami has had a tangible effect. But one could some
    time in the future equate this effect to taking five
    aspirins in one go to cut down high fever…Time will tell,
    perhaps before year’s end.
    JPM

  • Mitch April 6, 2010, 7:11 pm

    Rich,

    Go read people like Jim Sinclair/Dan Norcini’s commentary and you’ll understand why gold is moving higher. I won’t throw in GATA although they are now mainstream on the Net and oversea’s. JPM and HSBC are responsible for keeping a LID on gold and silver, not the other way around. The recent CFTC hearings confirmed all of that. The State-run media in the USA is still doing a fine job of brainwashing the public about what’s really going on. It appears to me that most Americans are just too plain dumb, or in complete denial, to understand the value of holding any gold/silver against an ever-depreciating and debased currency.

  • photoradarscam April 6, 2010, 6:42 pm

    “Rather, the push toward $90 a barrel represents speculative excesses in the futures markets, exacerbated by the reluctance of traders to take short positions. ”

    Maybe, but my guess is that the push towards $90 represents the devaluation of the dollar. The USD index doesn’t reflect this, but that is probably more of a function of how it’s computed rather than any meaningful indicator. If the Euro and the USD go down together, the move won’t be reflected in the USD index. However, we will notice that devaluation in the price of commodities, and lately, commodities like oil are on fire for no real reason. Therefore I must conclude that it is not the price of oil (and commodities like copper) going up, rather it is the value of the USD going down, along with the Euro.

  • Jason April 6, 2010, 6:26 pm

    As you were saying, Rick, there is no real recovery.

    I think the problem is the bond market. The last few auctions of long-term bonds have effectively failed. There were buyers for only a small amount of the bonds. Then, nothing. Suddenly, mystery buyers (or the Fed as many speculate) came in and took 90% or more of the remaining bonds.

    The bond people refuse to buy. The Fed cannot keep buying bonds indefinitely. Interest rates have to go up to entice buyers. It is likely that the “recovery and inflation” is spin to raise interest rates without spooking people.

  • Rich April 6, 2010, 6:11 pm

    Roger Lowenstein, author of When Genius Failed (LTCM) and While America Aged (GM,NYC, OC), has another interesting book out: The End of Wall Street, chronicling the fall of an entire generation…

    http://www.cnbc.com/id/36193141

  • Rich April 6, 2010, 6:03 pm

    But hey, two thirds of Americans think now is the time to buy a house, with the same or higher prices over the coming year, according to guess who, Fannie Mae.
    Maybe Uncle Sam will make the payments too…

    http://www.cnbc.com/id/36192494

  • Rich April 6, 2010, 5:55 pm

    Right on Rick re oil being a speculative bubble (Big4 called Crude correctly UP from lower prices.) COT shows Producers and Users short Crude while managed money is extremely long, creating artificial demand like bailout pork stim bankrupting governments. Big4 short most of the industrial commodities, including gasoline, consistent with an economy that produces relatively little of tangible value. InterestingBig4 peak electricity just went long for the first time in a long time. Maybe the iPad or Clash of the Titans in 3D.
    Tough to live on electrons when coal being cut.
    We may not have lasting real recovery until America becomes self-reliant, stops military massacring civilians and learns to produce for herself again.
    http://www.msnbc.msn.com/id/36182383/ns/world_news-mideastn_africa/
    15,000 more Healthcare IRS agents and Cap Trade suggest this may be at least until the next elections replace incumbents for a change. Interesting to see the CA Chamber of Commerce savaging Moonbeam Brown even before the primaries for being a borrow, spend, tax old style politician, and EBay CEO Meg Whitman exposed for amnesty for illegals plan like Obama. Maybe politicians know the Titanic left port.
    Re the Faber/Mish debate, they’re both right re higher 1980 CPI, currently +10%, and asset deflation. Still do not understand how someone can forecast asset deflation and higher gold prices on the same page, let alone paragraph, sentence or breath.
    Lincoln, FDR and Nixon violated the Constitutional gold standard some time ago, so there is no price support for gold except greed ads and the same fickle speculative money pushing crude. ABX may have put the $1226 top in on gold last December when they announced they spent $5 B to buy back their hedges…
    Regards*Rich

    • C.C. April 6, 2010, 7:03 pm

      “Lincoln, FDR and Nixon violated the Constitutional gold standard some time ago, so there is no price support for gold except greed ads and the same fickle speculative money pushing crude.”

      Interesting…

      ‘Price support’ (in my mind anyway) translated in today’s geopolitical marketplace, means:

      Confidence.

      (in the system, $currency, or both)

      Or, lack thereof.

      Am I off?
      ____________

  • JohnJay April 6, 2010, 3:34 pm

    Obama is begining to look more and more like Lyndon Johnson to me. The final chapter of the Great American Welfare/Warfare Experiment. Poverty in this country is worse than ever, and we still have not really won a war since 1945. Trillions of dollars wasted over almost 50 years and this country is now bankrupt and hated as a war criminal around the world. Politics!

  • gary leibowitz April 6, 2010, 3:04 pm

    The signs of recovery are real. Inventory is low, manufacturing is picking up, job gains are occurring. None of these things are delusional. The problem is that we are starting at such high saturation of debt and insolvency that it is virtually impossible to “pretend” the new mountain of debt can ever be repaid.

    The real question is who will flinch first. Will the bond market be the first to realize that the risk is just too high? Will governments take desperate measures to sustain a tenuous recovery by protectionist means? Will another major government default create a domino effect? Pick your poison.

    I suspect the stock market has another leg up to perhaps SPX of 1250 before it’s all over. Whether it occurs today or 3 months from now the pattern throughout history hasn’t changed. Human nature is a constant and as such will naturally gravitate to its perceived “norm”. No one accepts bad news easily. Most will either ignore or pretend it’s a short term problem.

  • FranSix April 6, 2010, 2:37 pm

    Discussion With John Rubino, in which you don’t often hear him discussing shorting junk bonds:

    http://www.howestreet.com/audiovideo/index.php?pl=/goldradio/index.php/mediaplayer/1604

    An interesting point of view -vis a vis junk bonds(if you want to ignore the gold discussion.)

    How To Short Junk Bonds

    http://www.forbes.com/forbes/2005/0905/168.html

    Access Flex Bear High Yield Weekly Chart

    http://stockcharts.com/h-sc/ui?s=AFBIX&p=W&b=5&g=0&id=p26850358719&a=196413844&listNum=2&listNum=2

    The problem with ETFs, once they sell off may have serious trouble advancing even if the underlying asset is trading up.

  • cp April 6, 2010, 2:32 pm

    I see this “recovery” talk, at least in part, as an inducement for for reluctant investors to get back into the equity market. There’s been a lot of “churning” going on but on thin volume, suggesting it’s still the big players using their computers incremently bidding up prices. But I believe they would love to take profits and dump their position on the less sophisticated, something they are very good at and have done a whole lot of. Profits aren’t profits until they’re taken, or is that no longer true? cp

  • Occdude April 6, 2010, 8:23 am

    Hollywood eh? Take away all the aforementioned supports and we could have another Mad Max movie for sure.

  • Chris T. April 6, 2010, 7:57 am

    see here for an interesting discusstion between Marc Faber and Mish Shedlock re: inflation and deflation:

    http://www.shtfplan.com/marc-faber/marc-faber-and-mish-on-inflation-deflation-doom-and-the-end-of-civilization_03142010

  • JohnJay April 6, 2010, 2:25 am

    Take away the:
    Section 8 rent supports
    Fannie, Freddie, FHA, ZIRP housing supports
    Sallie tuition supports
    Food Stamp grocery supports
    Department ofAgriculture farm supports
    Earned Income Tax Credit supports
    Unemployment Insurance anti-revolution supports
    Etc., etc.
    What is there left of a real economy in the USA?

    &&&&

    In a word: Hollywood! RA