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View Full Version : Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen



EJ
06-08-10, 02:01 PM
http://www.itulip.com/images2/bernankeratesJune2010-300.jpg

Starting in mid 2009, six months after the Fed managed short-term interest rates to close to zero, every very few months the Fed makes noises about raising interest rates or an article appears in the business media that makes the case for Fed tightening. Consider the Oct. 19, 2009 Barron's cover ``C'mon, Ben'' that admonished Bernanke to abondon the ultra-low rate policy and raise short-term interest rates "to a more normal 2% -- or risk fostering another financial bubble."

It takes more than beer to make a party and more than low interest rates to get an asset bubble going. It needs a catchy theme like the New Economy of the technology bubble era, a guest list of hopeful suckers, and a source of funding such as Venture Capital. Someone has to send out invitations, as the National Association or Realtors did during the housing bubble, and someone else has to publicize the event the way the business media did during both recent bubbles. Without the whole package, no bubble.

The Japanese can tell you all about it. The Bank of Japan dropped interest rates to near zero in 1995. Fifteen years later there's no new bubble in sight.

A mere 18 months into zero interest rate policy or ZIRP, the risk of a new bubble should be the least of our concerns. Managing asset prices up in the FIRE Economy without producing commodity price inflation in the Productive Economy is the primary challenge for U.S. monetary policy going forward. It's like trying to barbecue steak inside a meat locker. Sooner or later it's all smoked meat.

Another rate hike false alarm

Yesterday, Bernanke issued a statement that at first blush looks like a change in the Fed's interest rate posture.

Fed Chairman Bernanke focussed on the state of the real economy with respect to normalising monetary policy, in a question-and-answer session at the Woodrow Wilson International Scholars dinners yesterday evening. He indicated that the FOMC would not wait for a sizeable decline in the unemployment rate or for a significant increase in inflation before raising its policy rate: "We can't wait until unemployment is where we'd like it to be, we can't wait until inflation gets out of control before we begin the process of normalizing interest rates." He said that the economic recovery remains "moderate" and that "the unemployment rate is going to be high for a while". However, he noted good momentum in consumer spending and business investment, saying: "There are some signs that the private sector is picking up the baton and moving the economy forward."

On the fiscal issues facing the southern European economies, Mr Bernanke said the Fed was watching the situation "very closely" and that the EUR440bn would cover the needs of those economies affected "for a number of years". On the US fiscal situation, he commented that: "The recession is too deep, the loss of tax revenue is too great, and the spending to try to support the economy and the financial system too large."
We seriously doubt the Fed won't wait to raise rates until more voters have jobs. The relevant charts that show the relationship between unemployment and Fed rate policy are:


http://www.itulip.com/images2/ppivsunemployvsfedtarget1982-june2009.gif


http://www.itulip.com/images2/ppivsunemployvsfedtargetRaise.gif
For the past two recessions, the Fed waited until six to 12 months after unemployment fell
before starting to raise rates


1983 was the exception that proves the rule. After years of inflation it took very high interest rates to convince the bond vigilantes that the Fed was serious about killing off inflation. To drive the point home, the Fed raised rates as soon as unemployment started to turn around.


http://www.itulip.com/images2/fedfundsdurationunemp1970-2010.gif
The one exception to the rule was in 1983; after years of high inflation the Fed raised rates coincident with
the beginning of a decline in unemployment


Will the Fed make an exception this time? We don't need to belabor the fact that we are not exiting a period of years of double digit inflation. That leaves us to consider the unemployment picture. Is the economy at risk of a sudden surge in demand-driven inflation from a surging labor market?


http://www.itulip.com/images2/durationunemploymentcomparedMay2010.gif
Unemployment continues to rise: not a prescription for rising interest rates


If the Fed intended to change the rules and raise rates before unemployment declined for six to nine months, they'd not likely do so when unemployment remains weaker than during any recovery over the past seven recessions. The only argument for breaking the rule is if inflation expectations are rising far more quickly than during previous recoveries. So far, that has not been the case.

Two Roads to Failure

The Fed has two ways to re-crash the reflated and not yet self-sustaining economy:

1) Raise interest rates before the FIRE Economy recovers
2) Fail to raise interest rates before inflation begins to cut off real growth in the Productive Economy

The Fed will talk about raising rates but will not raise rates for at least another year. Here's the scenario for raising rates a year from now.


http://www.itulip.com/images2/fedratehikeprojectionJune2010.gif


If unemployment begins to decline from May 2010 levels A, and if inflation expectations continue to climb as they have since Sept. 2009 B, then the Fed may raise rates a year from now C.

Considering the extraordinarily high starting point of unemployment, the risk of inflation pressures from primary demand seem exceedingly low. Duration of unemployment needs for fall precipitously for many years to reach the 10 week level that signaled to the Fed that the economy no longer needed ultra-low rates. Recall that the housing bubble produced the rise in employment that relieved the labor markets after the tech bubble crash. Without a Next Bubble, where will the labor demand come from this time?

Even if these events do occur, there's still the FIRE Economy, especially the nationalized housing market, for the Fed to worry about. Even a modest rise in mortgage rates will slam the housing market.

Finally, consider Bernanke's comments on the deficit. If the Fed raises rates too soon and crashes the economy, guess what happens to the deficit when tax revenues decline even more than they have, even if outlays are not broadened to rescue the next wave of unemployed voters? When the IMF announces austerity plans for over-indebted countries from Argentina in 2000 to Greece in 2010, it's a firing gun for capital flight; when the Fed announces rate hikes when unemployment remains above 9% and 40 million Americans are on food stamps, guess what happens to the capital that had been previously flowing into the country in search of low risk yield?

As I've been saying, this is not a drill. Our economy is in a horrific bind of multi-generational proportions. The gold market is broadcasting loud and clear what it believes the outcome will be: a debt and currency crisis as governments over-extend themselves in an effort to bail out economies that went into crisis as a result of over-leverage in the private sector. <!-- edit note --> Is the event forecast by Ka-Poom Theory (http://www.itulip.com/kapoomtheory.htm) in 1999 and exended by the housing bubble finally upon us?

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don
06-08-10, 05:55 PM
EJ, straighten me out on this.


Even a modest rise in mortgage rates will slam the housing market. Are not housing prices fixed on the monthly ability to pay? (I'm foregoing actual construction cost in this question. Existing "previously owned" housing stock only, not developer's on-hand supply.) Then would not a raise in interest rates see an accommodating lowering of pricing to maintain the sell-able monthly amount? Do not near-ZIRPs help to keep housing prices artificially elevated?

In an iTulip essay from a few years back that point was quite clearly made. What am I missing?

FRED
06-08-10, 06:02 PM
EJ, straighten me out on this.

Are not housing prices fixed on the monthly ability to pay? (I'm foregoing actual construction cost in this question. Existing "previously owned" housing stock only, not developer's on-hand supply.) Then would not a raise in interest rates see an accommodating lowering of pricing to maintain the sell-able monthly amount? Do not near-ZIRPs help to keep housing prices artificially elevated?

In an iTulip essay from a few years back that point was quite clearly made. What am I missing?

The key point of this analysis is that low interest rates are keeping the housing market, not to mention the banking system, alive. That's the main reason why the Fed will not raise short-term rates even if other conditions are met, such as falling unemployment and rising commodity price inflation. Higher interest rates will be quickly reflected on the long end of the yield curve, including mortgage rates, making homes less affordable on a monthly basis causing home prices to fall. Homes are the collateral of mortgage debt. Lower home prices creates more bad existing loans.

gnk
06-08-10, 06:23 PM
How would the Fed react to an exogenous factor that pushes up price inflation? Such as...

Chinese workers are getting raises: http://www.nytimes.com/2010/06/08/business/global/08wages.html

or

Instability in the Middle East - oil skyrockets.

vinoveri
06-08-10, 06:33 PM
It takes more than beer to make a party and more than low interest rates to get an asset bubble going. It needs a catchy theme like the New Economy of the technology bubble era, a guest list of hopeful suckers, and a source of funding such as Venture Capital. Someone has to send out invitations, as the National Association or Realtors did during the housing bubble, and someone else has to publicize the event the way the business media did during both recent bubbles. Without the whole package, no bubble.

The Japanese can tell you all about it. The Bank of Japan dropped interest rates to near zero in 1995. Fifteen years later there's no new bubble in sight.



But are'nt we americans supposed to be more "inventive" than the Japenese? :)) (where are the emoticons anyway?)
In any case, we have their failure to generate a sufficient bubble as something to learn from.
Do the powers that be really want another bubble? If so, then surely they are smart enough to have been seeding it in this ZIRP period. Hey that free money has to go somewhere ( perhaps zombewhere is more appropriate) ... to balance the bad debts and reliquify banks and perhaps; I agree, it's not employment but the sustainability of FIRE that is the goal (b/c with FIRE another bubble and with that employment will take off).

So, how can we recognize, (not the early stages of the bubble even though that would be nice), but the seeds of the next bubble, i.e., policy decisions, and posturing of the politicos, and FIRE industry actions??? We know they want a bubble and are either thinking hard about it and have probably already laid the groundwork.

FRED
06-08-10, 07:41 PM
How would the Fed react to an exogenous factor that pushes up price inflation? Such as...

Chinese workers are getting raises: http://www.nytimes.com/2010/06/08/business/global/08wages.html

or

Instability in the Middle East - oil skyrockets.

This article resulted from a subscriber question to Ask EJ. Taking questions on that forum: Are fed rates going to rise soon? (http://www.itulip.com/forums/showthread.php/15848-Are-fed-rates-going-to-rise-soon)

Chomsky
06-08-10, 08:33 PM
This article resulted from a subscriber question to Ask EJ. Taking questions on that forum: Are fed rates going to rise soon? (http://www.itulip.com/forums/showthread.php/15848-Are-fed-rates-going-to-rise-soon)


Link's broken.

ThePythonicCow
06-08-10, 08:49 PM
Link's broken.
The correct link is Are fed rates going to rise soon? (http://www.itulip.com/forums/showthread.php/15848-Are-fed-rates-going-to-rise-soon)

FRED
06-08-10, 08:52 PM
Link's broken.

Fixed it. Thanks! ;_WP

jtabeb
06-09-10, 12:28 AM
"As I've been saying, this is not a drill. Our economy is in a horrific bind of multi-generational proportions. The gold market is broadcasting loud and clear what it believes the outcome will be: a debt and currency crisis as governments over-extend themselves in trying to bail out economies that went into crisis as a result of over-leverage in the private sector. <!-- edit note -->"

Can we just call this "hyper-inflationary depression" a Spade and be done with this none sense? (I know, I know, we have to wait for the POOM first. Still, is ANYONE doubting the trajectory we are on. The only question left is one of timing).

ThePythonicCow
06-09-10, 12:34 AM
Still, is ANYONE doubting the trajectory we are on.Only a few cows, but what do they know :D?

I figure they will have a go at re-basing the world's monetary system from the Dollar to some SDR-like (say the Wocu (http://www.wocu.com/wocu/)) reserve currency, and that it will take a few more decades at least for us to learn the hard way the limitations of that approach.

Adeptus
06-09-10, 01:53 AM
I was wondering if anyone had some insights on a similar question but in regards to Canada. Recently, on June 1st, the BoC (Bank of Canada = US Fed), dipped its pinky toe and tested the waters of market sentiment by raising the rate by 25 basis points. Canada was the first of the G7 to do so btw. The result was a sell-off in the Canadian dollar by almost 2 cents in one day, which was opposite of what I was expecting since I was under the impression that like Australia, interest rate hikes, means dollars return to your country and currency valuates higher against other major currencies. Anyway, various "expert" interpretations of the BoC announcement were provided here (http://business.financialpost.com/2010/06/01/bank-of-canada-raises-rates-economists-reaction/). (worth a read if you are interested in Canada)

For the past many years, as per the chart below..

http://www.clevelandfed.org/research/commentary/2009/0909-3.gif

...Canada nearly always mirrored the US Fed in regards to interest rate hikes & cuts. While the BoC is still leaving its options wide open and could hit the pause button at any time should the global markets go into another downward spiral cutting off inflation & Canadian GDP growth, its stated intent is to return back to the historic 2-3% norm. So it is entirely possible we see a few further 25 basis point increases for the remainder of the year, but I would be surprised to see Canada ultimately go off on a different tangent than the US fed for very long.

Any insights on this matter? I'm closely watching the Western Canada real estate market, and while it may very well start tanking (price wise) any month now, a continuous set of interest rate hikes, would push variable mortgage rates higher and immediately accelerate the over extended housing bubble up here.

http://www.chpc.biz/images/APR10-6City.jpg

... Found another relevant chart...
http://www.creditslips.org/.a/6a00d8341cf9b753ef0128776b373b970c-500wi

Thanks,
Adeptus

LargoWinch
06-09-10, 09:31 AM
Only a few cows, but what do they know :D?

I figure they will have a go at re-basing the world's monetary system from the Dollar to some SDR-like (say the Wocu (http://www.wocu.com/wocu/)) reserve currency, and that it will take a few more decades at least for us to learn the hard way the limitations of that approach.

TPC, do you believe that the Wocu will have a gold component?

For my part, I think it will be essential in order to sell this new currency to the masses.

Jay
06-09-10, 09:49 AM
TPC, do you believe that the Wocu will have a gold component?

Looks like no is the answer:

"Q2. Is Gold not the best store of Value?
Answer:
The WDX Organisation does not include gold in its basket. Gold may be priced in Wocu and this allows the markets to see the price of gold marked to a less volatile yardstick. The Wocu may be a valuable contribution to the pricing of gold, a volatile instrument in a class of its own. Opinions will always differ as to whether gold is the best way of storing value. "

bill
06-09-10, 10:05 AM
TPC, do you believe that the Wocu will have a gold component?

For my part, I think it will be essential in order to sell this new currency to the masses.

Bunker Oil
http://www.navitasresources.com/pressrelease.asp

Ben live
http://www.c-span.org/Watch/Media/2010/06/09/HP/R/33926/Fed+Chair+to+Assess+American+Economy+Sees+Economic +Growth.aspx

Chris Coles
06-09-10, 12:04 PM
With the run in to the first budget of the new government under way here in the UK the same debate applies to us as well. Here, I expect to see a move towards forcing the executive to work within the tax income which will be reduced by a measure for repayment of debt. So here also, there would be no incentive to drive raising the rate.

But there is another aspect to this that is worth remembering. Low interest rates are a prerequisite for long term equity investment. Once savers realise they cannot see a return to banking their savings and earning an income above inflation, then the drive becomes irresistible to find a better home for the savings. In past times, that would have been "markets" of one form or another. But this time, that route will diminish as regulatory effects take hold and suppress the use of the savings in that sphere.

It will soon dawn on many that the one place they might see a reasonable return will be from what are normally described as most risky, local community investment of equity capital into local small and medium businesses. Not for the expectation of a rising asset value for the share which will not trade on any market. But instead, from the dividend income. If such SME's realise they can gain friendly local investment if they provide a reasonably secure 8% annual return from their annual dividend; then a new phase of investment will start. But that will not be under FIRE rules, but true free enterprise rules.

Policy makers need to realise the potential. But that will in turn bring them a downside. If savings start to run into such investments; then they stop flowing into the FIRE coffers and are not available for the use of the government. The more established bond markets will dry up if the flow of savings changes direction.

The next few months will show us where the regulators want the flow to go.

ThePythonicCow
06-09-10, 05:06 PM
TPC, do you believe that the Wocu will have a gold component?

For my part, I think it will be essential in order to sell this new currency to the masses.
The Wocu does not have a gold component at present, as others have noted above. I don't see any way that the Wocu could be directly modified to contain a gold element and maintain its current selling strengths, as an apolitical meta-currency weighted against a basket of all the worlds major national currencies.

The Wocu isn't sold to the masses; individual nations (or regions, perhaps, with the Euro) keep their national currencies. The Wocu is only "sold" to major players in the Forex markets, such as national central banks and big energy and transportation interests.

The Wocu would hope to become the world's reserve currency, the meta-currency, the currency in which national central banks settle accounts and hold reserves, and the currency in which major inter-national contracts for transportation and energy might be written, replacing the Dollar in its reserve currency role.

Gold comes into the scene indirectly, as holdings of various national central banks, in varying degrees and as "insurance" (the same reason you or I hold gold in the long term) for the day that such international fiat currency arrangements collapse.

P.S. -- When and if gold is commonly quoted in Wocu rather than Dollars, we will likely hear familiar sounding allegations from us gold bugs that the price of gold in Wocu/gram is being "managed" by the GIS/IMF/G20 and their central banks, in order to lend credence to the sustained value of Wocu. I'd expect we'd see the Wocu/gram price of gold fall for a decade or two, as we did with the Dollar/ounce price after the early 1980's Dollar crisis.

P.P.S -- Ultimately it would be this falling price, in Wocu/gram, of gold, over a period of a decade or more, that would drive a substantial quantity of gold from smaller private hands back into central banks. That re-centralization of gold is something I also anticipate, and mentioned IIRC yesterday in some other post somewhere here on iTulip. Investors usually seek to hold what's increasing in wealth and to divest themselves of what is declining in value.

ThePythonicCow
06-09-10, 05:36 PM
P.P.P.S. -- Gold "backed" the Dollar in an indirect way in the two decades between the early 1980's and the early 2000's. It was commonly priced in Dollars, and its Dollar/ounce price was declining over that period, which us Conspiracy <s>Cows</s> Nuts blame on central bank and bullion bank manipulation. When you choose to price your product in units established by your "arch enemy" and when they have the power to manipulate that price, you're pwned. Gold was no longer the stronger money backing the Dollar; Gold was being abused by the Dollar Masters to the benefit of the Dollar. I am predicting this scenario will repeat, with the Wocu.