Economic opinion

[ziggy]

The Best Medicine ? Fed Rate Hikes

It?s now official. The Federal Reserve is done with its interest rate cuts. Despite the jump in the unemployment rate to 5.5%, Fed Chairman Ben Bernanke said on Monday night that he thinks the economy had passed the danger zone and that the Fed would pay close attention to inflationary pressures.  The Chairman said the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so." Referring to rising expectations of inflation as seen in consumer surveys, Bernanke added that the FOMC would strongly resist an erosion of longer-term inflation expectations.
This is good news for economic growth. As long as the Fed was in a rate cutting mode, investors, potential homebuyers and businesses held off on making decisions. Why borrow and buy today, if interest rates will fall further in the future?

However, there is still a wide open question as to when the Fed might begin to hike rates. The futures markets have priced in a high likelihood of rate hikes as early as August and an almost certain 25 basis point hike by October. But just a few months ago they were suggesting further Fed rate cuts, and Fed Vice-Chairman Don Kohn is arguing that inflation is still not a problem.

If the economy acts as we believe and accelerates toward a 3%+ real growth rate in the third quarter, we suspect a rate hike could come as early as the August or September meetings. Some say the Fed will wait until after the election, but there is no incumbent and it is hard to see how rate hikes would benefit one candidate over another.

Way Behind the Curve
Three things seem certain from our vantage point. First, the Fed is way behind the curve. Second, the longer it waits to hike rates the more inflation will become imbedded and the harder it will be to eradicate.  Third, rate hikes when the Fed is behind the curve do not result in bad news for the economy or investors.  In order to judge the real (or inflation-adjusted) federal funds rate, many economists have historically used consumer price data. However, the CPI has come under attack lately for underestimating inflation. Moreover, businesses face inflation from many fronts. So, as an added piece to the analysis of Fed policy we went back and compared the federal funds rate to the ?core? producer price index for finished goods.

As the charts show, the federal funds rate dipped below the core produce price inflation rate in late 2003 and then again recently for the first time since the negative real rates of the late 1970s and the early 1980s. In other words, monetary policy in the past six or seven years has been the most accommodative since the misguided policy of the 1970s that Paul Volcker was brought in to address.  In the 1970s, commodity prices exploded to the upside, just as they have in recent years. While Fed economists continue to blame global demand pressures on inflation, the truth is staring them in the face. Monetary policy is just too easy.

Negative real interest rates are an unambiguous sign of excessively easy Fed policy and they must be corrected to get inflation under control. While some analysts, including economists at the Fed, argue that inflation is likely to stabilize on its own, history suggests otherwise. Inflation is caused by easy monetary policy, and therefore until the Fed tightens and pushes up real rates, inflation will continue to
rise.

The question is: how high? One way to think about this is to compare real interest rates during periods of benign inflation. During the 10 years ending in 1999, the average real federal funds rate (using the core PPI) was 3.3% and in that period inflation was benign.  Adding this 3.3% to today's core PPI increase of 3.0% suggests that the federal funds rate should be lifted to 6.3% in order to simulate the same policy of the 1990s. This is slightly above the 5 - 6% rate we arrive at with our nominal GDP model.

Bad for Stocks?
Recent declines in the stock market, especially in financial stocks, have increased  concerns that Fed rate hikes will hurt equity values. But this is not supported by history. Between mid-2004 and mid-2006 when the Fed lifted rates from 1% to 5.25%, the S&P 500 increased roughly 15%. And with the real federal funds rate (using the core PPI) averaging 4.4% during the 20 years ending in 1999, the S&P 500 climbed 12-fold.

On the other hand, the stock market has performed miserably in the past nine months as the Fed has cut rates. The high real rate policy of the 1980s and 1990s was good for equities, while the low real rate policy of the 1970s and the 2000s has been bad for equities.

There are many reasons for this. Low inflation lifts P-E ratios, while high, or rising inflation reduces them. In addition, high inflation increases the odds that the Fed will have to fight aggressively to bring it down, raising the specter of a Fed-induced recession.

Conclusion
Contrary to conventional wisdom, Fed rate hikes would be the best medicine for what ails the US economy today.  If we are right, and the Fed starts hiking rates later this year, the dollar will rise, commodity prices will fall and equity markets will recover strongly. The best course of action is not always the easiest.

Brian S. Wesbury, Chief Economist
Robert Stein, Senior Economist

Believe it he speaks the truth!!!

[rickortreat]

This man is a complete idiot, and if you believe the Fed can afford to actually raise interest rates in this economic environment, you're crazy too!

The current wave of inflation is a global phenomenon, the inevitable result of the aggressive currency policies of a number of trading partners.  Most of the new, rising economies are doing so, by underbidding the older manufacturers in the established countries. They have geared themselves to sell to the US consumer, so purposely kept their currencies artificially low in relative terms.  Over the long term, the inevitable result is that nothing is made in places like the US, and everyone has all the dollars they need from selling us all this stuff for the last 15 years.

Now everyone has dollars and they are using them to buy everything they can.  They understand the dollar is going down in value, so they are speculating in commodities and natural resources in order to preserve and profit from their wealth. That is what is causing inflation, the easy monetary policy in the US fueled a world-wide boom, most note-ably in China, India as well as Taiwan, Korea and Japan.

Well now that the world is awash in dollars of course oil is going up.  Now the Chinese are driving cars too.

And the US is still spending beyond it's means and producing less and less exportable goods. Until the US changes it's policies so that we only trade with countries who allow their currencies to float, we will always be subject to the corrosive influence of predatory trading partners.

And if we don't reduce spending and try to pay down the deficit, the inflation situation will get worse.  Raising interest rates now would be suicide, since the housing market was the only thing in the US that benefited from the easy money policy- along with the stock market.  Now that both those bubbles have burst, both houses and stocks are now subject to a massive re-valuation.  Raising interest rates will only serve to force these revaluations even lower.

The US is already in a recession, and companies are still laying off employees. The only thing that the country can do is try to rebuild it's standing by stopping the current inflation by not printing so much money!  They don't even publish M3 figures anymore, because then they would see that the Fed is inflating the currency above 10% per annum.  With an economy addicted to credit, raising interest rates at this time would induce a depression. 

[ziggy]

Rick,
Here is a quick bio on Brian Wesbury
Brian Wesbury is Chief Economist at First Trust Advisors L.P., a financial services firm based in Lisle, Illinois and serves on the Board of Advisors to First Trust Capital Partners, an affiliated private-equity firm. The Wall Street Journal ranked Mr.Wesbury the nation's #1 U.S. economic forecaster in 2001 and USA Today
ranked him as one of the nation's top 10 forecasters in 2004.

Mr. Wesbury writes frequently for the editorial page of The Wall Street Journal and is the Economics Editor of The American Spectator.  In 2007, he was named a CNBC Contributor.  Mr. Wesbury is a member of the Academic Advisory Council of the Federal Reserve Bank of Chicago and is also an adjunct professor of economics at Wheaton College in Wheaton, Illinois.  Additionally, he sits on the Board of Managers of Three-Sixty Advisory Group, a Pasadena, California based consulting and private-equity firm.
 
Mr. Wesbury began his career in 1982 at the Harris Bank in Chicago. Former positions include Vice President and Economist for the Chicago Corporation and Senior Vice President and Chief Economist for Griffin, Kubik, Stephens, & Thompson. In 1995 and 1996, he served as Chief Economist for the Joint Economic Committee of the U.S. Congress.

Mr. Wesbury received an M.B.A. from Northwestern University's Kellogg Graduate School of Management, and a B.A. in Economics from the University of Montana.


So Rick let me give you a piece of advice.  Stay quite and people may think you are a fool, open your mouth and you remove all doubt.

[Lurker]

ziggy...give up, it's no use.

I figured out in the last thread that anyone who claims that the entire system is collapsing and the way to escape the collapse is to buy certain "securities" put out by that system is lost.  He is just playing the same game as everyone else.  If the system is truly collapsing then you should be stocking up on canned goods, arms & ammunition.

[Reality]

If the system is truly collapsing then you should be stocking up on canned goods, arms & ammunition.

 
How about dvds of the Spurs Championships in 030507?
And of course the Kings-Lakers fixaroo of '2

[Lurker]

If the system is truly collapsing then you should be stocking up on canned goods, arms & ammunition.

 
How about dvds of the Spurs Championships in 030507?
And of course the Kings-Lakers fixaroo of '2

Because if the world's economic system is collapsing you won't have any electricity to power the DVD player.

[Reality]

checklist should include a generator?

Shouldn't WoW, Laker Fan Dan, westkoast, msc, Randy and indeed the whole Laker House gang see the 2002 Game 6 proof before the end comes?

[ziggy]

ziggy...give up, it's no use.

Lurker,
I know you are right.  Sometimes though it is hard to drive by a car crash and not slow down and gawk.

[rickortreat]

I don't care what the man's bio says.  He doesn't understand economics well enough to make an economy work in the real world, he only knows enough to impress other academics who also think they are economists but are actually failures.

Ask two economists even from the same school and you will get two different opinions. Both will sound impressive and well-thought out, but it is quite possible neither will be correct.

Most economists are Keynesyans at heart, and that is what is taught in the Universities.  It is garbage incarnate as Keynes believed in bending the rules to accommodate difficult economic circumstances.  An Economist of the Austrian school would have told everyone that when Greenspan started using the Fed to support the markets when LTCM collapsed that he was setting a dangerous precedent, and setting the stage for a much greater collapse down the line.

I told you the housing market would collapse and you all told me I was wrong.  I told you that gold was going to the moon, when I first started posting the price was about $350 an Oz. now it's $870 an Oz.

So go ahead and ignore me and my free advice.  I don't need followers to tell me I'm correct in my views, the reality of what is occurring is all the evidence I need to know that my opinions are correct.

Since my last post has the stock market gone down further or not?  Has the housing market collapsed or not?  Has gas gone over $4 a gallon or not?  I don't have a crystal ball, but I don't need one to make these predictions. They are the natural outcome of stupid fiscal policy  (based on my understanding of economics) - the kind of policies fabricated by your friend Westbury, who thinks the policies are perfectly rational! 

By all means keep listening to these wonderful academicians, Greenspan, Bernake, Westbury.

What's the point of even posting when you don't even use your brain to consider whether I am right in my thinking or not?  Like all the California posters all you do is insult people who disagree with you. 

Why don't you use your head instead and see the economic path these geniuses have led us on? How can you come to any other conclusion other than that they are clueless?

[ziggy]

Like all the California posters all you do is insult people who disagree with you.

What's the point of even posting when you don't even use your brain to consider whether I am right in my thinking or not? 

Why don't you use your head instead and see the economic path these geniuses have led us on? How can you come to any other conclusion other than that they are clueless?

This man is a complete idiot, and if you believe the Fed can afford to actually raise interest rates in this economic environment, you're crazy too!

Boy now that is pot calling the kettle black, Mr. Personality.  I didn't call you any names, I just posted a famous quote, after you called me a complete moron.  So Rick I will be delicate, go f... yourself!!!!

By all means keep listening to these wonderful academicians, Greenspan, Bernake, Westbury.

Please show me where Wesbury supported the rate cut policies of Bernanke, and Greenspan and where I supported the policies of Bernanke?  Come on Rick, if you want to call names, and pick fights then please back up your accusations with demonstrable facts.  I will be waiting for you to find what doesn't exist.

Wesbury has been pounding the Friedman monetary policy creed for years.  How do you think Mises, Hayek, Mencken, Sowell and Rothbard would respond to our present state of affairs, or the state of affairs since September, when the Fed started cutting rates?  Would they have proposed pumping excessive liquidity into the system, cut rates to the point where the real fed funds rate is negative?  If you believe that Rick, then all I can say is pull out your Rothbard, or Sowell, or Mises and start reading again.

Most economists are Keynesyans at heart, and that is what is taught in the Universities.  It is garbage incarnate as Keynes believed in bending the rules to accommodate difficult economic circumstances.

Wesbury has been saying for years that the Fed has been too loose with money, and those actions lead to our present state of affairs.  The loose money lead to $130 a barrel, a housing bubble like no other, commodity prices running out of control, gold at $1000 an ounce.  How you take what Wesbury is saying and turn him into a neo-Keynesian boggles the mind.  He is the opposite of a Keynesian.

His whole point Rick, and if you would go back and read it again is this.  The gas crisis of the '70's and the high inflation of the '70's, just like the high gas prices and high inflation today are functions of loose monetary policy.  His point is very simple Rick, whenever the Fed Funds rate falls below the Core PPI, you will set off a round of rapid inflation.  It happened in the late '70's, and it took 2+ years of aggressive inflation fighting monetary policy by Paul Volker to get it under control.  It happened again in 2003 when Greenspan cut rates to 1%, below the core PPI, and WHAM.  Gold went through the roof, and housing inflation (which is not measured by the CPI) went through the roof, and commodities have have had their single longest bull market ever, with virtually every commodity at all-time highs.

The only thing that the country can do is try to rebuild it's standing by stopping the current inflation by not printing so much money!

Earth to McFly, what do you think Wesbury is saying?

I don't care what the man's bio says.  He doesn't understand economics well enough to make an economy work in the real world, he only knows enough to impress other academics who also think they are economists but are actually failures.

Too all Laker fans, I accused you all of hubris a few weeks back.  I apologize, this is the absolute description of hubris.

That is what is causing inflation, the easy monetary policy in the US fueled a world-wide boom, most note-ably in China, India as well as Taiwan, Korea and Japan.

Rick, I don't think the Japanese Prime Minister or the Japanese people got that memo.

Raising interest rates now would be suicide, since the housing market was the only thing in the US that benefited from the easy money policy- along with the stock market.  Now that both those bubbles have burst, both houses and stocks are now subject to a massive re-valuation.  Raising interest rates will only serve to force these revaluations even lower.

Rick, please detail for me what has happened since September 18 (happy birthday JN) when the Fed began this rate cutting cycle?  Please show me how all of these rate cuts have actually turned the horrible housing market around.  Have mortgage rates fallen?  Have home price increased?  Has the months of inventory gone down?  Have permits, home starts, pending sales, sales of existing homes, or any other meaningful measurement improved since the Fed started cutting rates?  The fed rates cuts since September have done nothing for housing, so please explain to me how raising rates is going to destroy housing.  The problem in housing is not high rates, the problem in housing is that home prices and inventory are too high, which has lead to record amounts of foreclosures, which had made that paper worthless, and made it cheaper and easier for homeowners to walk away from bad mortgages and get the same home for much less money just down the street.

What has happened to the price of oil since the rate cut started?  It was about $73 a barrel, and today it is $130+.  Has there been a massive increase in demand since mid-September, or has the supply fallen drastically?  Raise rates, strengthen the $, and oil will fall, and so will virtually every other commodity.

On October 1, just after the first rate cut the Dow was at 14,147.30, and on June 11, 2008 the Dow was at 12,116.58.  That is a drop of 2030 points a drop of 16.9%.  So the Fed rate cuts didn't help the stock market.

Wesbury has been saying this all along, and that is what happened.

[rickortreat]

Like all the California posters all you do is insult people who disagree with you.

What's the point of even posting when you don't even use your brain to consider whether I am right in my thinking or not? 

Why don't you use your head instead and see the economic path these geniuses have led us on? How can you come to any other conclusion other than that they are clueless?

This man is a complete idiot, and if you believe the Fed can afford to actually raise interest rates in this economic environment, you're crazy too!

Boy now that is pot calling the kettle black, Mr. Personality.  I didn't call you any names, I just posted a famous quote, after you called me a complete moron.  So Rick I will be delicate, go f... yourself!!!!

"So Rick let me give you a piece of advise stay quite (BY the way the word is quiet not quite)and people may think you are a fool, open your mouth and you remove all doubt."

You implied something there and you can stick that up yours, Sir!

By all means keep listening to these wonderful academicians, Greenspan, Bernake, Westbury.

Please show me where Wesbury supported the rate cut policies of Bernanke, and Greenspan and where I supported the policies of Bernanke?  Come on Rick, if you want to call names, and pick fights then please back up your accusations with demonstrable facts.  I will be waiting for you to find what doesn't exist.

Wesbury has been pounding the Friedman monetary policy creed for years.  How do you think Mises, Hayek, Mencken, Sowell and Rothbard would respond to our present state of affairs, or the state of affairs since September, when the Fed started cutting rates?  Would they have proposed pumping excessive liquidity into the system, cut rates to the point where the real fed funds rate is negative?  If you believe that Rick, then all I can say is pull out your Rothbard, or Sowell, or Mises and start reading again.

-I think that Rothbard, Sewell and Mises would all agree that the problem started with Greenspans excessive monetary accommodation, and that once you have created a monetary bubble that has burst there is nothing you can do, except let the inevitable financial destruction take place. This is because the incessant inflation flows to certain sectors of the economy forcing their valuations out of harmony with the rest of the various goods and services.  Therefore, since things like stock values and bond values and housing prices are out of whack, the challenge is to create a system that allows these things to return to normal valuation levels. The problem in doing so is that people feel incredible pain if they are holding an asset who's value is suddenly too high.

It is this problem that has engendered the current solution, even more accommodative monetary policy.  In an effort to save people from the pain of loss.  Since the problem has affected housing which is were most people keep the majority of their wealth, it would be political suicide to raise rates.  You see, all the big investment banks and many of the large Central Banks bought in to the US market bubble, and they are all stuck and they are all pissed.  You may have noted the problems with the stock prices of Citi, Leh, and GS in recent times.  Between them and the other financial players are parts of paper that supported the housing bubble: Credit Default Swaps, Interest rate swaps, and other even more creative derivatives.  It is these things that are the problem since they are unregulated, without standards and without a functioning market.  The people who hold these things know they will go belly up if interest rates rise.  So yes, you could slow inflation by raising interest rates now, but if you do, say good-bye to over half the financial institutions in this country, with no JPM to pick over the carcass with govt. help like they did with Bear Stearns!  And at the same time, say good-bye to Fannie Mae, Freddi Mac and the other govt. sponsored financial institutions, because rising interest rates will bankrupt them and cause massive losses to their bond holders.

Most economists are Keynesyans at heart, and that is what is taught in the Universities.  It is garbage incarnate as Keynes believed in bending the rules to accommodate difficult economic circumstances.

Wesbury has been saying for years that the Fed has been too loose with money, and those actions lead to our present state of affairs.  The loose money lead to $130 a barrel, a housing bubble like no other, commodity prices running out of control, gold at $1000 an ounce.  How you take what Wesbury is saying and turn him into a neo-Keynesian boggles the mind.  He is the opposite of a Keynesian.

-Well, he's a monetarist like his mentor Milton Friedman. Not quite a Keynesian, but almost as bad!  Now if Westbury had said we need to reduce monetary aggregates, I would have called him a genius but he didn't.  In fact Volker himself didn't get that until he had a talk with his friends at the BIS, who told him to stop printing so damn much money while he was raising interest rates.

His whole point Rick, and if you would go back and read it again is this.  The gas crisis of the '70's and the high inflation of the '70's, just like the high gas prices and high inflation today are functions of loose monetary policy.  His point is very simple Rick, whenever the Fed Funds rate falls below the Core PPI, you will set off a round of rapid inflation.  It happened in the late '70's, and it took 2+ years of aggressive inflation fighting monetary policy by Paul Volker to get it under control.  It happened again in 2003 when Greenspan cut rates to 1%, below the core PPI, and WHAM.  Gold went through the roof, and housing inflation (which is not measured by the CPI) went through the roof, and commodities have have had their single longest bull market ever, with virtually every commodity at all-time highs.

-2003 was the second bubble- or did you forget that the stock market first crashed in 2000?  Greenspan lowered rates to push off a recession then, so we could enjoy it now that he's left office.  I would agree with all his statements linking this round of accommodative policy to the apparent inflationary conditions. Where we disagree is the solution.  Volker was chairmen of the Fed when I just got out of school and you may recall the fallout that occurred later on with the savings and loan scandal once his policies really started to take hold.  The economy went through a lot of pain in the 1980's and in-spite of Volkers' efforts the budget deficit was much higher by the time Regan left office. It stopped inflation in it's tracks, but the US failed to take the next step and fix the flawed world trade model that created the inflation in the first place.

The only thing that the country can do is try to rebuild it's standing by stopping the current inflation by not printing so much money!

Earth to McFly, what do you think Wesbury is saying?

He's saying raise interest rates to lower demand for money.  What I am saying is that if you do that, you will destroy the world's financial institutions, and disrupt the actual economy to such a degree that world economic activity would decline by a factor of over 10% for starters.   Instead, what I would suggest is that the Fed start issuing M3 figures again - the one statistic that tells you what the Fed is really doing (Expanding monetary aggregates at a rate of over 10% per annum.) So that their is more transparency in the market place, and people can more clearly see what is happening.  Then, I would address the trade issues that allow other countries to target private businesses in the US and undermine them by subsidizing their industries to take market share.

Once we can establish compliance with proper free-trade rules between different countries, and the US economy stabilizes to the point where we are producing sufficient goods and services to offset what we consume from the rest of the world, so that currencies are able to trade freely, we can re-establish a gold cover clause to facilitate trade and force countries to face the consequences of rapid monetary expansion more directly.

I don't care what the man's bio says.  He doesn't understand economics well enough to make an economy work in the real world, he only knows enough to impress other academics who also think they are economists but are actually failures.

Too all Laker fans, I accused you all of hubris a few weeks back.  I apologize, this is the absolute description of hubris.

It's not hubris if you really understand the situation better!

That is what is causing inflation, the easy monetary policy in the US fueled a world-wide boom, most note-ably in China, India as well as Taiwan, Korea and Japan.

Rick, I don't think the Japanese Prime Minister or the Japanese people got that memo.

They got is all right, where do you think the money came from for round 2 of the inflation monster during Greenspans term?  Japan financed the second bubble and created the YEN CARRY TRADE to try to kick start their economy, which was in a recession as a result of competition from Korea, Taiwan and finally China. Ironically Japan, who initiated the entire model for predatory command control economies is now suffering greatly as other less developed nations adopt the same policies for their domestic development!
 

Raising interest rates now would be suicide, since the housing market was the only thing in the US that benefited from the easy money policy- along with the stock market.  Now that both those bubbles have burst, both houses and stocks are now subject to a massive re-valuation.  Raising interest rates will only serve to force these revaluations even lower.

Rick, please detail for me what has happened since September 18 (happy birthday JN) when the Fed began this rate cutting cycle?  Please show me how all of these rate cuts have actually turned the horrible housing market around.  Have mortgage rates fallen?  Have home price increased?  Has the months of inventory gone down?  Have permits, home starts, pending sales, sales of existing homes, or any other meaningful measurement improved since the Fed started cutting rates?  The fed rates cuts since September have done nothing for housing, so please explain to me how raising rates is going to destroy housing.  The problem in housing is not high rates, the problem in housing is that home prices and inventory are too high, which has lead to record amounts of foreclosures, which had made that paper worthless, and made it cheaper and easier for homeowners to walk away from bad mortgages and get the same home for much less money just down the street.

-It will destroy housing since no one will have any money of be able to buy a house and it will destroy the financial institutions as their derivates they bought to protect themselves fail to perform and they go into default.  All of the firms that came into being as a result of the accommodative action of the fed will be destroyed, if you start to raise interest rates.  Instead what they are doing is spreading the pain far and wide in terms of inflation.

What has happened to the price of oil since the rate cut started?  It was about $73 a barrel, and today it is $130+.  Has there been a massive increase in demand since mid-September, or has the supply fallen drastically?  Raise rates, strengthen the $, and oil will fall, and so will virtually every other commodity.

-The falacy here is that raising rates will strengthen the dollar.  If you raise rates but still expand the money supply, you will accomplish nothing but engender even more inflation. If on the other hand, you keep rates stable and address monetary aggregates - supply and demand for money, NOT credit you can start to arrest inflation.

On October 1, just after the first rate cut the Dow was at 14,147.30, and on June 11, 2008 the Dow was at 12,116.58.  That is a drop of 2030 points a drop of 16.9%.  So the Fed rate cuts didn't help the stock market.

Wesbury has been saying this all along, and that is what happened.

So have I, but for somewhat different reasons.  I don't think that Westbury understands the full implications of an interest rate rise at this point in the cycle.  All policies are adapted to by the people, who will choose the path of least resistance in order to be successful. When these policies only further the current imbalance, adjusting interest rates is like wagging the dog's tail, after he's dead, rather than actually feeding him.