Macroeconomic Warning Goes Unheeded

by: Ockham Research posted on: May 01, 2008 | about stocks: DIA / IEF / SPY    

Chairman Bernanke and the Federal Open Market Committee [FOMC] have a tough set of challenges to guide the U.S. economy through. First, Wednesday the Commerce Department reported that the U.S. economy grew by .6% in the first quarter of the year, which matched the same rate of tepid growth displayed in the last quarter of 2007. Many economists had forecast that this quarter’s economic numbers would be negative, signaling that the domestic economy had entered a recession in the first months of 2008 driven by severe weakness in both the housing and credit markets. Yesterday’s results will stave off the “r-word”--at least for a while. The results were significantly better than the .15% growth that a Bloomberg survey had predicted. Furthermore, with the President’s economic stimulus checks being mailed out in the near future, it is less likely that the second quarter GDP will sink into negative territory because consumption is such a large part of overall GDP. So, on the whole, the economy is growing, albeit ever so slowly, but this is only part of the picture.

The FOMC announced yesterday that it will lower the overnight bank–to–bank lending rate by a quarter point to just 2%. Even though this is what Wall Street had wanted and expected, the stock market plunged after the announcement. We hope that this will be the final rate cut in what has been a short and aggressive cutting campaign that Chairman Bernanke has used as a means to ward off recession.

Unfortunately, this rate cutting has exacerbated nascent inflation and global consumers are feeling the effects of rising prices from the gas pump to grocery store aisles. The Consumer Price Index is up over 4% (annualized) so far this year and much of that rise is attributable to a 17% increase in energy prices over the last 12 months. Food prices have fared somewhat better, but on average consumers are paying 4.5% more for food than a year ago. The Fed’s recent easing of monetary policy has demonstrably increased inflationary pressures and devalued the dollar. Global commodities are valued in dollars and when the dollar’s value falls, the whole world pays more for commodities. This invariably triggers an inflationary spiral that punishes the consumer.

We would have much preferred that the FOMC--armed with the slightly positive GDP data--would have left rates unchanged in order to take a stand against inflation and escalating commodity prices. There is a lag in the effect of monetary policy, and current inflationary pressures show little sign of dissipating. While the early rate cuts that the Fed used to spur economic growth were probably necessary to avoid a recession, we have reached the point of diminishing returns. The Fed’s earlier heavy-handedness weakened the dollar and fanned the flames of inflation, which could have a more adverse effect going forward than allowing the economy to contract for a quarter or two. Further weakness in the dollar, which Wednesday’s modest rate cut could trigger, will lead to still higher food and energy prices for the foreseeable future, which will further strain economic growth and possibly prolong the economic slowdown.

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This article has 6 comments:

  •  
    continuum
    May 01 06:58 PM
    With the open scam of understating inflation and thus overstating "real" (my ass) GDP, Fed is effectively USING inflation to fight recession, on paper. The monetary policy has lost its real content and become a number manipulation game.

    If one used any reasonable inflation adjustment factor as opposed to the openly scandalous "core (my ass) CPI", GDP growth would have been negative since Q4-07, in line with reality.

    But with the current number-gaming, we have and will continue having inflation AND recession without realizing it.

    The stupidity is mind boggling.
  •  
    aSpadaSpade
    May 01 08:37 PM
    Mind boggling stupidity as the market gobbles up the "bottom is in" good news is a gargantuan understatement. No longer able to discern between spin and reality the entire country has lost it's bearing and hears only what it wants to hear.
  •  
    karchad
    May 01 10:30 PM
    aSpadaSpade, I heard the same garbage all of 2003 and 2004. Every bear market brings out the "you're stupid if you're in the market" people. I've made money of you guys for 40 years. Plenty of it.
  •  
    aSpadaSpade
    May 02 06:04 AM
    And Karchad, I heard the same garbage you are spewing all through 2000-2002. An endless stream of CEOs, journalists and analysts proclaimed the end was in sight as they enticed people into riding tech all the way to the bottom. You are a perfect example of the idiotic greed that pervades the country and, against all reason thinks there is another huge pyramid scheme bull market in the making. Go for it sucker. Ignore the fact that the financial system has suffered the worst shock since the 30s, the fact your country is pumping billions in the endless pit of a loosing war, that the entire population has been living beyond it's means on credit for decades and there is NOTHING more than talk and a fed shell game to solve the problem.
  •  
    iThinkBig
    May 02 03:28 PM
    My Website
    I will hopefully put some class into both aSpada and Karchad's comments. Many economic bubbles emulate from Republican economic policies surroundin major technological innovations and this trend has occured since 1870 and here's some other years with booms and busts: 1908, 1929, 1967, 1987, 2001 and now 2008. It is not coincidence that these dates coincide with big innovations such as railroad, radio, business computers, the Internet. The exception to true innovation, stock/market booms was this latest innovation into real estate and mark to market financial asset skullduggery.

    While the other innovations busted and then became mainstream industries with slow but multi-decade growth, real estate was reinvented and repackaged as derivatives, with a AAA rating applied when much of it was junk and sold globally. Global investor confidence is out the window. It was a bubble that created massive wealth, but only for those on the top of the Ponzi scheme. The intention and hope may have been that the U.S. consumer could outspend the correction in housing in other sectors but the liquidity crisis and inflation has now crushed consumer sentiment. While these other bubbles/innovation periods could recover, trickery financials gimmicks is NOT a multi-decade long industry that can create new jobs or fix Main's Street's or Financial Sector problems.

    Now to your point Karchad of making vast sums of money for forty years, it is obvious you have known when to invest into the bubbles and when to exit (I exit 3 months after when denial begins that a bubble exists in the first place). There is no shame of being a smart capatalist but it is not proper business etiquette to skewer other investor's whom are pointing out the real facts of what is going on in our economy, that the U.S. has begun losing value in a global competitive environment and does not have the proper fundamentals for a health economy in the mid-term.

    Last point: I am a Republican was ashamed at my party (politicians and bankers alike). Both groups took advantage of the distraction of this Administration's focus on the Iraq war & keeping the U.S. safe from nuclear 911 and fleeced the system. The profit's came from the little guy in America and this is heinous, selfish business practice. Republican's have the best capatalistic for the American economy in general but historically have never been able to time pricking/deflating the bubbles at the right time to avoid bust. For example, strong economists were shouting from the rooftops in early 2006 to prick the housing bubble.

    Reality is, the U.S. is going to go through 3-4 years of economic contraction, unless we innovate our way out of it and alt energy (including domestic drilling) to me is the global investment vehicle which if implemented will stave off depression. In any event, global recession is guaranteed based on my numbers (minus 2nd half year blip due to stimulus).
  •  
    wsigler
    May 02 05:43 PM
    To I-THINK-NOT: First of all, aspadeaspade seems to me to have lost more sense and class than you can ever hope to have. You lost me as soon as you said "I will hopefully put some class into both aSpada and Karchad's comments. Many economic bubbles EMULATE....". You need to meet Mr. Webster...or does he, too, not have enough class for you.
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