Presentation to I HEDN. Key Themes for the U.S. Economy. New York, 9 June 2011. Grant Rogers Partner, Metis Capital Management LLC. Key Themes for the U.S. Economy. How Strong is This R ecovery? Inflation Employment Debt. Recovery: How Strong?.
Key Themes for the U.S.
New York, 9 June 2011
Partner, Metis Capital Management LLC
income rose by 7.1% for the former and by only 2.4% in the latter case.
U.S. industrial production was at multi-decade highs, due to a weak dollar, but slowed in May to 53.5 from 60.4 in April. Readings above 50 indicate expanding activity. June 30 will see the end of the Fed’s fiscal stimulus (QE2) at which time the dollar may begin strengthening, which may have a negative effect on the manufacturing sector.
But Adjusted For Population Growth and Inflation, and Stripping Out Gasoline, A Different Picture Emerges…This chart would suggest that the recovery is weak and may be stalling
Source: Dshort.com, St. Louis Fed, Consumer Price Index.
Exports Are Climbing, Helped by a Weak DollarU.S. growth is being driven by exports, and the chief beneficiaries are multinational companies like Caterpillar, G.E., or Intel. Since the recovery started in the third quarter of 2009, exports have contributed about 1.4 percentage points to the nation's 3.0% annualized growth rate. Exports benefit from a lower U.S. dollar, but this is not necessarily helping small companies of 250 people or less, which employ half the country. Furthermore, a lower dollar places a heavy burden on the U.S. consumer, who relies on imported goods which are now more expensive.
Alternate Unemployment Charts
Were it not for this, foreclosures would be considerably higher.
Conclusion: Home prices will continue to fall substantially, with corresponding “negative wealth effect” on consumers.
Quantitative easing is an unconventional monetary policy used by central banks to stimulate their economy when
Conventional monetary policy has become ineffective. The central bank buys government bonds and other types of
bonds, with new money that the bank creates electronically in order to increase money supply and the excess reserves
of the banking system. This action also raises the prices of the financial assets bought, which lowers their yield.
Quantitative easing shifts monetary policy instruments away from interest rates, towards targeting the quantity of
In the mid 1990’s, there was an increase in productivity linked to
U.S. consumers mistook that increase in productivity. They overestimated how large the increase in future productivity
and income would be. Consumption and debt rose accordingly relative to income, while savings rates went down
dramatically. There had to be a readjustment.
With the credit crisis, there was the appearance of a readjustment, whereby the savings rate went from around 2% to
6% Between 2007 and 2010. However, this adjustment was due almost entirely to a decrease in taxes, not a decrease
in savings. In other words, up until 2008, household debt increased dramatically, until the 2008-2011 period when
government debt took over. This represents a transfer of debt from households to government, but amounts to the
same thing. Nothing has really changed since 2008 households are still spending, and not investing much. At some
point, there will be another crisis.
The crisis might be blamed on former Fed chairman Greenspan for keeping “real” interest rates
negative in the 2003-2005 periods. But whoever is to blame, the resulting policy response by the
Federal Reserve was without historical precedent.
The first major policy response came to be known as “Quantitative Easing”, which involved the
Federal Reserve Bank buying treasury bonds with electronically created money.
Banks absorbed this liquidity provided by the Fed, willingly. In fact, they wanted to hold reserves at the Federal
Reserve, because they thought it was safe. Usually, a bank takes one dollar of deposits and lends out 9 dollars. This is
called the reserve ratio. The reserve ratio during the credit crisis went from 9:1 to 1:1. In other words, for every dollar
of deposits, banks were only willing to lend out only one dollar.
This fact was largely missed by the media, because it was one of the most extraordinary changes in the banking
landscape in the past 200 years. Individuals, companies, and banks ALL wanted cash, because it was considered a safe
way of storing wealth. Demand for cash increased to record levels, and it led to deflation in 2008 and 2009.
Prices and inflation are a balancing act between the supply and demand for money. If the demand for cash explodes,
what happens if you don’t add supply? You get deflation because the demand for money goes up relative to the supply
of money. An excess of money meant that there were more dollars per unit of things to buy.
Quantitative Easing II, on the other hand was something completely different.
Whereas in QE1 the Fed acted as a monetarist should, QE2 was a Keynesian exercise. By the end of 2010, the
demand for money was coming down because the level of panic in the U.S. and worldwide was subsiding. In
November of last year, the Fed decided to purchase another $600 billion of treasury securities. The supply of
money was now increasing significantly, and this is inflationary.
The second round of quantitative easing was intended to increase consumer demand for goods and services
by increasing money supply. A monetarist would say that this will simply lead to inflation. QE2 really should
have had a different name from QE1. The Fed thinks that when inflation begins, they will be able to drain
liquidity quickly enough to stop it. They feel they will be able to
counter rising inflation by:
There are three problems with this however.
Is the Fed ready to act proactively against inflation? This is the important question.
The weakness in the economy will not hold back inflation. This is a very Keynesian concept, and an
You need only look at Argentina and Brazil in the 1980’s, where inflation was not linked to the strength of
the economy. It was related to money, the absolute amount of money in the economy.
These countries were creating money through the payrolls of government employees.
The risk we face today in the U.S. economy is that the Federal Reserve Bank governors may not
understand the difference between QE1 and QE2. There seem to be a number of them who appear to
be Keynesian. In their speeches they aren’t being tough on inflation at all, saying that inflation can’t take
off because the economy is still weak.
But this is a myth. Historically, there is little evidence that inflation and output are related.
Increased money supply (relative to demand) actually has a much bigger impact on speculative asset
bubbles, such as the one that we are currently seeing right now in commodities. In 2005 and 2006, the
relative increase in supply vs, demand for money didn’t show up in traditional inflation, but in asset
bubbles: housing, commodities, and oil.
This leads to boom/bust cycles.
Source: May 2010 CBO Deputy Director Robert Sunshine's presentation to the Fiscal Commission Congressional Budget Office
General Gross Government Debt (% of GDP)
U.S. Federal debt is now at $9.7 Trillion. This is what the U.S. Treasury owes the public from their sales of short term bills, medium term notes, and long term bonds. This number includes all debt owed to U.S. and international investors, money market funds, central banks of other countries, and private banks.
This figure does not include $4.6 trillion in IOU’s that the federal government has promised to its own programs like Social Security and federal employee pensions.
The federal debt limit that we read about in the press, that is currently being debated in the Congress, is the total of the two, or $14.3 trillion.
This is the size of the pension, medical care, and disability benefits for former members of the U.S. armed forces.
Federal Employee Retirement Benefits:
This is funded with taxes or borrowing. The federal government employs around two million people.
State and Local Government Obligations:$5.2 Trillion
Only half of this debt is explicit. The rest is hidden in the form of pension shortfalls and promises made to medical costs for retired workers.
Official vs. Unofficial Debt Ratios
A record 18.3% of the nation's total personal income was a payment from the government for Social Security, Medicare, food stamps, unemployment benefits and other programs in 2010. Wages accounted for the lowest share of income — 51.0% — since the government began keeping track in 1929.
According to projections by the U.S. Congress, the Social Security fund will run deficits every year until its resources are completely drained in 2037. At that point, Social Security would collect enough in payroll taxes to finance 78% of the benefits. More than 54 million people receive retirement, disability, or survivor benefits from Social Security today, and the average monthly check they receive is $1,076.
In 2011, Social Security will run a $45 billion deficit and continue to run deficits which will total $547 billion over the next ten years.
The Social Security Act was created by Roosevelt in 1935 when average life expectancy in the U.S. was 61.7 years. Now, life expectancy is 78 years. (Source: National Center for Health Statistics, National Vital Statistics Reports, vol. 54, no. 19, June 28, 2006.).
While the retirement age has now been raised from 65 to 67 in the U.S., the problem is both demographic and due to increased longevity.
JagadeeshGokhale, CATO Institute, Consultant to the U.S. Treasury
“The United States would need to save and invest an amount equal to 8.2% of its GDP beginning now and continuing every year forever to pay expected future benefit without future tax increases. This could be accomplished by more than doubling the current 15.3 percent payroll tax on employers and employees, immediately and forever. Alternatively, the federal government could imme- diately stop spending nearly four out of every five dollars on programs other than Social Security and Medicare — eliminating most discretionary spending on such programs as education, national defense, environmental protection and welfare — forever. Each year that the United States does not take action to reduce the projected shortfall, it grows by more than $1.5 trillion, after adjusting for inflation .”
In Dec. 2009, the head of the Chinese state owned Assets Supervision Commission said “we recommend China increase its gold reserves to 6,000 metric tons within three-to-five years and possibly to 10,000 tons in eight to 10 years.” Considering that China now has reserves of 1,054 tons, this would imply buying about two and a half to 4.5 years of annual gold production. Some speculate that China is trying to replace its $2 trillion + dollars with gold, but there is reason to believe that it is preparing to launch the Yuan as a convertible currency and would like to back its credibility with gold. The Chinese government is encouraging openly its citizens to put at least 5% of their savings into precious metals.
The Federal Reserve’s Trade Weighted Index measures the US dollar’s performance against seven currencies, and hit record lows last month.
Also caused by:
larger the gap in that deficit.
No Reserve Growth In Middle East
Source: Bloomberg, BP Statistical Review
Burgeoning BIC Electricity Demand
ChIndiaA Key Driver In World Energy Demand
Source: US Energy Information Administration
This chart reflects an estimate of inflation today as if it were calculated the same way it was in 1980.
Food prices have been identified as one trigger for North African uprisings.
In this and recent years (2008), food riots have impacted:
Argentina Morocco Mozambique Jordan
Tunisia Yemen Senegal Peru
Egypt Sudan Bangladesh Bolivia
India Pakistan Morocco Haiti
Indonesia China Peru Cameroon
Chad Somalia Ethiopia Mexico
Guinea Mauritania Senegal Uzbekistan
Source: Wall Street Journal