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Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

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  • Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen


    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:





    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.


    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?


    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.



    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. Is the event forecast by Ka-Poom Theory in 1999 and exended by the housing bubble finally upon us?

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    Last edited by FRED; 06-09-10, 12:30 AM.

  • #2
    Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

    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?

    Comment


    • #3
      Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

      Originally posted by don View Post
      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.
      Ed.

      Comment


      • #4
        Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

        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/bu...l/08wages.html

        or

        Instability in the Middle East - oil skyrockets.

        Comment


        • #5
          Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

          Originally posted by EJ View Post

          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.

          Comment


          • #6
            Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

            Originally posted by gnk View Post
            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/bu...l/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?
            Last edited by FRED; 06-08-10, 08:50 PM.
            Ed.

            Comment


            • #7
              Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

              Originally posted by FRED View Post
              This article resulted from a subscriber question to Ask EJ. Taking questions on that forum: Are fed rates going to rise soon?

              Link's broken.
              Last edited by FRED; 06-08-10, 08:51 PM.

              Comment


              • #8
                Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                Originally posted by Chomsky View Post
                Link's broken.
                The correct link is Are fed rates going to rise soon?
                Most folks are good; a few aren't.

                Comment


                • #9
                  Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                  Originally posted by Chomsky View Post
                  Link's broken.
                  Fixed it. Thanks!
                  Ed.

                  Comment


                  • #10
                    Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                    "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. "

                    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).

                    Comment


                    • #11
                      Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                      Originally posted by jtabeb
                      Still, is ANYONE doubting the trajectory we are on.
                      Only a few cows, but what do they know ?

                      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) 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.
                      Most folks are good; a few aren't.

                      Comment


                      • #12
                        Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                        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. (worth a read if you are interested in Canada)

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



                        ...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.



                        ... Found another relevant chart...


                        Thanks,
                        Adeptus
                        Last edited by Adeptus; 06-09-10, 02:12 AM. Reason: 1x grammar + 1x aesthetics, 2% to 2-3%, + added 1 chart@bottom, + additional comments in 1st paragraph
                        Warning: Network Engineer talking economics!

                        Comment


                        • #13
                          Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                          Originally posted by ThePythonicCow View Post
                          Only a few cows, but what do they know ?

                          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) 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.

                          Comment


                          • #14
                            Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                            Originally posted by LargoWinch View Post
                            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. "

                            Comment


                            • #15
                              Re: Don't hold your breath waiting for Bernanke to raise rates - Eric Janszen

                              Originally posted by LargoWinch View Post
                              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/20...ic+Growth.aspx

                              Comment

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