Friday, October 29, 2004

The remarkable failure of the Greenspan-Bush "stimulus" has always been its complete inability to wean itself from a housing wealth effect. Without job growth and wage/salary growth, this grand experiment in Big Government Conservatism will end very badly.

And if you needed any more confirmation that a 0.4% personal savings rate is only the tip of the iceberg, CNNMoney gives us a similar story from the Employment Cost Index.

Employment costs rose by slightly less than expected in the third quarter this year, up 0.9 percent, as benefit costs posted their smallest rise since early 2002, a government report showed Friday.

Wall Street had forecast the Employment Cost Index, a broad gauge of what employers pay in wages and benefits, to rise 1.0 percent between July and September versus a 0.9 percent gain the previous three months.

. . . salaries and wages gained 0.7 percent versus a 0.6 percent rise in the previous three months.

Over the past 12 months, wages and salaries are up just 2.4 percent, the smallest 12-month change in the history of the series, which began in 1981.
In nominal terms, the wages and salaries component of the ECI is indeed at its lowest point since the series began. However, the real (inflation-adjusted) ECI is not. In 2004:III real wages and salaries (per the ECI and deflated by the PCE price index) are up 4.2% so far over the Bush years. This number combines, however, the robust growth of 2001 with the the significant recent slowdown. Real wage/salary gains were either stagnant (2003:IV) or actually falling (2004:I-II) until this summer. Over the last year, they stand at a mere +0.2%.

Our current economy is frightfully dependent on disinflation. And when you're at 1%, you'll soon need outright deflation to keep people flocking to the checkout counter.

The media headline measure of inflation in the US is the Consumer Price Index (CPI). The Federal Reserve has its own favorite measure, however, the price index for Personal Consumption Expenditures (PCE). Today's numbers on the third quarter show PCE inflation took a major nosedive this summer.

During the deflation scare of late 2003, annual PCE inflation was running at 1.7% and core PCE inflation at just 1.2% Over the three months of July-September 2003, core annualized inflation was a mere 0.9%.

During early 2004, everyone forgot deflation and starting crowing about inflation, or perhaps the awful "stagflation". Annual PCE inflation hit 2.3% in 2004:II, and annualized quarterly inflation in the first half of 2004 was over 3.0%.

Those days are long gone. Annualized quarterly inflation plummeted from 3.1% in 2004:II to 1.1% in the third quarter. Core annualized inflation plunged as well, although less dramatically, from 1.7% to 0.7%.

2004:III was profoundly disinflationary, driven by remarkable deflation in durable goods (-3.2%) and barely positive inflation (+0.9%) for nondurable goods. We are now at the lowest level for quarterly core inflation at any time during the Bush administration -- well below even the deflationary scare levels of 2003.

As noted below, the somewhat robust 3.7% GDP growth in the third quarter was heavily dependent on motor vehicle and parts consumption. This gives me a chance to blow my deflation horn as well as highlight one of my favorite deflationary data points.

In the third quarter, new vehicle prices (NSA) changed another -1.6% in nominal terms and -1.9% in real terms. As of September 2004, nominal new vehicle prices are -6.5% since 1997; in real terms, they are -21%.

In the 21st century, GDP growth depends on goods deflation. Real prices fall, we consume more than we would if prices were stable or rising, consumption figures increase, GDP goes up. We draw down the equity in our homes and borrow from abroad to keep the wheel turning. At a savings rate of 0.4% and threats of a falling dollar thanks to a current account deficit in the range of $600bn this year, we'll have to start selling our property off outright soon just to stay above water.

UPDATE: After reading comments on this post, I realized I was being a bit coy with the phrase "selling our property off outright". Commentor big al cuts through the niceities:
"What do you suppose China will buy with your dollars? Land and or mineral resources I suppose. They are already getting into the Tar Sands, perhaps the coalfields in the US, or forests. How soon before you can't have them, because the owners ship the products to China?"
Recall all the fuss about Japan buying up everything in sight in the US during the late 1980s? Now replay that for the 2000s but with communists in the lead role. Sound fun?

With the blistering pace of retail sales and home construction/sales in the third quarter, folks were expecting a bit more than what they got out of this morning's GDP report from the Commerce Department.
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.7 percent in the third quarter of 2004, according to advance estimates released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 3.3 percent. . . .

The major contributors to the increase in real GDP in the third quarter were personal consumption expenditures (PCE), equipment and software, exports, government spending, and residential fixed investment. The contributions of these components were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, increased.
While in normal times 3.7% would be considered just fine, these are not normal times. GDP growth these days translates very poorly into wage/salary growth or job creation, as I've already discussed. Moreover, economists were hoping for much more in the third quarter.
Analysts were predicting that the economy, which Federal Reserve Chairman Alan Greenspan had said hit a "soft patch" in the late spring, would gain traction and expand at a more brisk 4.3 percent rate in the third quarter.
The biggest turnaround in the GDP figures for 2004:III was for personal consumption expenditures. In 2004:II they grew a mere 1.6%; in the third quarter they surged a whopping 4.6%, led by a big 16.8% rise in expenditures on durable goods. Faithful readers of the Globblog will remember that incentive-driven car sales frenzy in September. In fact, motor vehicle and parts consumption constituted a full 80% of the growth in durable goods consumption for the quarter, and that after eroding overall durable goods consumption numbers for nine straight months (2003:IV-2004:II). Without the surge in car and truck sales (and assuming Americans would have saved that money rather than spent it on something else -- let me live in my fantasy world for just this sentence, already), 2004:III real GDP growth would have been a mere 2.6%.

With all that consumption, one might think that Americans' income was rising at a healthy clip as well. One might also be wrong. Real disposable personal income rose just 1.4% in 2004:III, the slowest pace since the recessionary days of late 2002. As a result personal savings was driven into the netherworld. The savings rate in 2004:I was 1.0%, and in 2004:II, 1.2%. In the third quarter, the personal savings rate dropped to an incredible 0.4%.

Let this sink in: in 2004:III, Americans saved out of their disposable income a mere $35.0bn. No wonder we're so desperately dependent on foreigners to float our annual $420bn budget deficit.

The result of all this spending without income is that over the first three quarter of 2004 the United States has tallied a personal savings rate of just 0.9%. If the fourth quarter savings numbers come in under 1.0%, we're looking at chalking up the lowest annual personal savings rate since 1933, the depths of the Great Depression.

Enjoy your 2005.

Thursday, October 28, 2004

To crash or not to crash? That is the question.
despite growing evidence of a slowdown in the market, the Nationwide ruled out any possibility of a market crash.

While the group did not rule out falls in "isolated months", it did not expect a sustained period of declines as the economy is growing quickly and the jobs market remains strong.

"Developments remain consistent with our view that over the coming years, house prices are more likely to grow at a very subdued rate rather than fall sharply," said Nationwide group economist Alex Bannister.

"Our view is the current moderation in price growth expectations will not translate into widespread panic and that instead the market will experience subdued levels of turnover and price growth." . . .

Some analysts said the Nationwide could be mistaken in asserting that the market is in for a soft landing rather than a crash.

Given Wednesday's government figures showing an increase in house repossessions, the signs suggest that current price levels are unsustainable, experts warned.

"We believe that prices need to fall by around 20% to put the market back on a more sustainable footing," said Ed Stansfield, a property specialist at Capital Economics.

"Thus we expect price falls, such as that reported by the Nationwide today, will be the dominant trend of the next two to three years."
The "no crash" set feels that interest rates will not go over 5% in the UK and so no crash can occur. Of course, this fails to take into consideration all those homebuyers who bought using ARMs, and thus will not feel the interest rate hikes immediately. Much depends on real wages as well. If these fall, even steady mortgage payments will grow in relation to the rest of the family budget. This is especially true in London and the Southeast where the housing price-to-income ratio is already quite high.



The fate of the London housing market seems to be the best possible future scenario for the bubbly US markets in California, Florida and the Northeast. With US interest rates having much further increases to come, real wage growth and job growth less robust, and much more desperately leveraged homeowners than even in the most expensive boroughs of London, the US story could easily look a lot worse, too.

Well, no sooner do I point out plunging long-term interest rates on Monday when, starting Wednesday, they take a dramatic upwards turn.

Just what the doctor ordered. At least, what Stephen Roach ordered.
The People's Bank of China lifted its one-year rate on bank deposits by 0.27 percent to 2.25 percent, AFX News reported from Beijing. It also lifted their six-month deposit and three-year and five-year deposit rates as well.

"This round of macro-control measures, including economic, legislative and necessary administrative measures, has achieved good results and the overall macro-economic and financial operation continues to move towards its targeted direction," the bank said in a statement.

"But to address recent conflicts and problems still existing in the financial and economic operations and to further consolidate the results achieved, the People's Bank of China has gained the approval of the State Council (cabinet) to raise benchmark interest rates."
Roach has been saying for some time that global rebalancing is essential to save the global economy from ruin. An essential part of that rebalancing is a new relationship between the dollar and the renminbi, one to which the Chinese have been the most resistant. On September 27 Roach opined,
I have been a diehard optimist on China for over seven years. But now I am worried that China is at risk of making a series of major policy blunders that are tied directly to its role in leading the new Asian way. It was one thing to maintain the RMB peg in the face of mounting world pressures to do otherwise in recent years. I still feel this was the right thing to do on a stop-gap basis -- in effect, providing China�s undeveloped financial system with an anchor during a critical phase of its integration into the global economy and world financial markets.

But now China is digging in its heels on interest rate policy -- refusing to deploy the conventional policy instrument that is widely accepted as the principal means to restrain an overheated economy. China, instead, prefers to use the administrative edicts of its central planning heritage -- controlling the quantity of credit and project finance rather than its price. The combination of these two policy rigidities is especially worrisome. China�s central bank must keep creating RMB in order to recycle its foreign exchange reserves back into dollars; this runs the grave risk of undermining China�s ability to control its domestic money supply. But now, by holding its interest rates down, China is encouraging the very excesses that are driving its overheated economy -- a massive investment overhang and mounting property bubbles in several important coastal markets, especially Shanghai. By freezing the currency and its interest rates, China is, in effect, forcing its own imbalances to be vented in increasingly dangerous ways. This is not sustainable.
Conventional wisdom says that this rate hike takes more steam out of the near-runaway Chinese locomotive, and especially its property and investment bubbles. Combined with more US tightening, the boil might just come off smoothly.

"There's no living player who can say what we can say today: We're the world champion Boston Red Sox." -- Curt Schilling

Wednesday, October 27, 2004

The ugly part of a popping housing bubble may be upon Britain.
The number of mortgages approved by banks fell for the fourth month in a row in September, figures have shown.

According to the British Bankers' Association (BBA), 59,905 property loans were granted last month.

This represented a 29% fall from the 81,635 new loans approved in September last year.

Meanwhile, figures from the UK government showed a rise in court actions to repossess homes, a further sign that rate rises were being felt. . . .

"I think this may be showing that some people have borrowed so much that they have become very sensitive to small changes in interest rates," said John Butler, UK economist at HSBC.
If the pinch is on in the UK, how much tighter will it feel in the bubbly US housing markets? Let's compare London with the ultra-frothy housing markets in Southern California:

Central bank interest rate changes, from recent low
UK . . . +1.25%
US . . . +0.75%

Price change for existing homes, 2000 to 2004:II
London . . . +48.6%
Los Angeles . . . +103.1%
San Diego . . . +107.8%
Orange County . . . +107.2%

Housing price-to-earnings ratio (est.), 2004
London . . . 5.5:1
Los Angeles . . . 9.3:1
San Diego . . . 10.7:1
Orange County . . . 10.4:1

So is the London housing market showing Southern California its future, but one to be repeated in spades under the palms trees? But of course, we know that long-term interest rates will never rise in the US, so we have nothing to worry about . . . and pay no attention to that massive current account deficit behind the curtain . . .

It looks as if fuel prices have found a port in the storm.
Crude-oil futures fell as much as 4 percent Wednesday with a significant climb in U.S. crude inventories . . .

Crude for December delivery climbed as high as $55.65 a barrel on the New York Mercantile Exchange, an intraday level the market has never reached in the 21-year history of futures trading.

But the December contract has since dropped back to $53.80, down $1.37. It traded as low as $53, its lowest level in a week.

November heating oil fell 3.71 cents to $1.531 a gallon, and November unleaded gasoline shed 4.05 cents to trade at $1.372 a gallon.

The Energy Department reported a 4 million-barrel climb in crude inventories for the week ended Oct. 22, to a total of 283.4 million. The American Petroleum Institute posted a 4.4 million-barrel rise and pegged total stocks at 281.2 million, after an upward revision to last week's total of 900,000 barrels.

The latest climb was around double what many analysts had been expecting.
On the retail side, gasoline prices ticked slightly downwards the week ending October 25 and now stand at a national average of $2.032/gal. That's still 49�/gal. higher than this time last year, of course.

At their all-time nominal peak early in late May and early July, US retail gasoline prices hit a four-week average of $2.042/gal. Over the most recent four weeks, the price has been $2.000/gal.

While this passes for good news on the gasoline front, the heating oil situation continues to look more and more ugly. For the week ending October 22, US distillate stocks were down to just 116.6 million barrels, -9.1% from six weeks ago. For the first time since February 2003, national distillate stock levels have fallen out of the very generous "average range" and declining for six weeks when they should be rising in preparation for the winter heating season. Perhaps most worrisome, distillate stock levels in the Northeast -- the region most dependent on heating oil -- are now at the lowest end of average and will fall out of that range unless a big turnaround occurs. Release of some of the 2 million barrels currently locked up in the Northeast Heating Oil Reserve has to be on the table.

In a bold move, OPEC is actually urging the US to tap its Strategic Petroleum Reserve to bring down oil prices. The implications are considerable.
OPEC cartel president Purnomo Yusgiantoro said on Wednesday he had taken the surprise step of urging the United States to use its strategic petroleum reserve (SPR) to lower oil prices.

``We had communication with them (the U.S.). I asked them to use their reserves,'' Purnomo, also Indonesia's oil minister, told reporters. He did not say what Washington's response was.

Purnomo's request to Washington is unusual as OPEC usually regards government stockpiles as a threat to its own market influence.
So OPEC is so afraid of high prices that it's willing to countenance -- nay, welcome -- rivals into the market? That says a mouthful.

Tuesday, October 26, 2004

Check out my latest post at The American Street today. It's titled "If GDP is so up, why am I so down?"

In light of the terrible consumer confidence numbers combined with third quarter growth coming in at around 4.0%, it points out a key dichotomy in the contemporary US economy. Here's a sneak preview:



In its uniquely reserved British style, the Bank of England is ramping up the deflation early warning system.
A member of the Bank of England's rate-setting Monetary Policy Committee (MPC) has given the first public indication that the Bank's Governor may soon have to explain to the Chancellor why inflation is so low and what the Bank intends to do about it. . . .

Every year the Chancellor sets a target rate for Consumer Price Index inflation which guides the MPC in setting interest rates. If the actual inflation rate goes above or below the target by more than one percentage point the Governor has to explain. It is currently 1.1 per cent compared with a target of 2 per cent.

Mr Lambert said: "House price inflation seems to be on the turn, and the pace of spending on the high street may cool off more rapidly than had been expected. It now seems unlikely that economic growth in the third and fourth quarters of this year will match the very strong performance of the second, so the pressure of demand may turn out to be less intense than might have been expected. Moreover, the trend of prices in industry's supply chain still looks quite muted." . . .

Mr Lambert noted that inflation was being held back by a "brutal" retail climate, while low unemployment was not pushing up wage rates as might have been expected. He said: "The employment rate has slipped a little, and the level of inactivity has risen. The number of average hours worked has declined, but for some reason the market doesn't seem to be getting any tighter. At the same time, the pace of regular pay growth in both the public and private sector appears broadly to have flattened out."

Mr Lambert admitted that it was hard to explain this apparent change of mood. But that inflation was set to remain low and stable in the UK despite violent swings in the prices of individual goods and services.
What better expression of the fact that deflation in the advanced capitalist countries is now structural?

Monday, October 25, 2004

The yield on the 10-year Treasury note just keeps on falling. Good thing the seniors just got a bump up on their Social Security payments, because they aren't making squat on their bonds.
U.S. 10-year Treasury notes rose, pushing yields to the lowest in almost seven months, on concern record high oil prices will slow growth in the U.S., the world's biggest energy consumer.

Ten-year yields have fallen 93 basis points, or 0.93 percentage point, since June 14 as oil prices surged. Economists predict a 70 percent gain in energy costs this year will sap consumer spending, slowing growth in the last quarter of 2004.

"There's three things" driving the Treasury market -- "oil, oil and oil," said Jitzes Noorman, a fixed-income analyst at Rabobank in Utrecht. "The momentum points to lower yields."
Clearly the fear of inflation is completely absent from the bond market. And in this environment, why not? Nobody really believes in cost-push inflation anymore, what with US labor lying prostrate at the feet of capital for some 20 years now.

In light of these falling yields, one has to wonder whether private capital will flow into the US at all? We know there are signs that capital is beginning to sour on US government debt (net -$5.1bn in August) and especially US equities (net -$13.6bn during March-August). Will US corporate debt be next?

Of course, we can always count on our Sugar Daddy -- aka the Bank of Japan -- to bring it all home for us in November -- and even a little attention from the Russian Central Bank on the side, too.

More unsettling news from the London housing bubble.
U.K. house prices fell in October at the fastest monthly pace since at least February 2001, according to the property Web site Hometrack, as five interest-rate increases since November damp demand for credit.

Home values declined 0.6 percent, the fourth consecutive decline, to 165,800 pounds ($303,099), after a 0.3 percent drop in September, the Web site said. The average price is at its lowest level since April. . . .

No region or city in the U.K. or Wales posted house-price increases in September, with London leading the declines. Home values in south-west, south-east and east London dropped 1.2 percent, while north London saw a 1.5 percent decline, Hometrack said.
Consider:
  1. the IMF has shown that housing prices are coordinated across the major industrialized countries;
  2. the average British worker has enjoyed much higher real earnings gains (+8.8%) than the average US worker (+0.6%) over the last four years; and
  3. the housing price to earnings ratio in the UK is far lower than in the bubbliest markets in the US
and you've got a forecast for a hard rain falling on the US housing bubble in 2005.

Friday, October 22, 2004

The US dollar is overvalued. That's the verdict rendered by the evidence of the US current account deficit, which promises to top $600bn this year, and the repeated efforts of the Bank of Japan to prop the thing up when it begins to fall. I did a little number over at The American Street yesterday talking about the 25% decline in the value of the dollar vis-a-vis other major currencies since early 2002.



Today the New York Times takes up the matter, urging both Bush and Kerry on to a repeat of the deal Ronald Reagan and the G7 orchestrated in the mid-1980s to bring down to high-flying dollar.
If Mr. Bush gains a second term, he need only recall what his role model, Ronald Reagan, did. After cutting taxes in the first term and seeing the trade deficit rise to previously unimaginable levels, he engineered the Plaza accord in the first year of his second term. The dollar fell and the trade deficit gradually narrowed. It is time to consider such a policy again. And whoever is elected may want to get that process started sooner rather than later.
OK, anyone who thinks Bush is anywhere near as reasonable as Reagan and will even broach the subject of tax increases is clearly living in fantasy land. But that's not the point. The point is that the Plaza Accord brought down a seriously overvalued dollar, and it would be nice to see such a thing take place today.

Matters are quite different today, however. In the 1980s the dollar (measured by the nominal major currencies index) peaked in March 1985 at 143.90, and the current account deficit peaked at 3.45% of GDP in the fourth quarter of 1986. Today the dollar (by the same index) is at 85.33 and the current account deficit at 5.7% of GDP (2004:II) and rising.

The upshot is that the USD was far far stronger in the 1980s than it is today, and that it has a lot further to fall today than 20 years ago.

For example, at its 1980s peak the undervalued British pound bought a mere $1.05. Today the undervalued pound buys $1.83. The overvalued dollar bought �262 in February 1985. Today the overvalued dollar buys only �107. Back in the day, one overvalued dollar could get you 3.45 Deutsche mark; now you can pull in just �0.80 -- or 1.56 DM.

As measured by the major currencies index, the post-1973 low point for the dollar was April 1995 when it bottomed out at 80.33. In an historical perspective, this is the definition of a "weak" dollar. By the same index, on Thursday the dollar stood 83.61. The "strong" dollar of today is a mere 4% higher than the weakest weak dollar of the post-Bretton Woods era.

If the USD needs to fall some 20% to bring the current account deficit under control -- as Michael Mussa among others believes -- then we're looking at a future with the weakest dollar in post-WWII history. Forget the looming catastrophes of the colonial project in Iraq. How in the world is the United States going to act as global hegemon riding the weakest currency in three generations?

Thursday, October 21, 2004

What more need be said than this:

The Red Sox win the pennant! The Red Sox win the pennant!



It's true -- this Midwesterner has gone native. As our golden-tongued Vice President would say, "Oh, yeah, he has, big time".

Wednesday, October 20, 2004

Yesterday the General penned a long analysis of the recent news out of the Treasury Department on transnational capital's sudden loss of interest in US assets. I ended with the mantra, "Three cheers for Japanese deflation!" because I think that as long as Japan is in deflation, their appetite for the USD is for all practical purposes infinite.

This issue is really causing folks to fret, however -- as it should -- moving from the pages of the business set Financial Times to the broader audience of the Washington Post:
. . . a rash of new data, including Treasury Department figures released yesterday showing a net sell-off by foreigners of U.S. bonds in August, has stoked debate over whether overseas investors -- private individuals, institutions and government central banks -- are growing dangerously bearish on the U.S. economy. . . .

Bond purchases by foreign central banks also dropped sharply in July, falling 76 percent, to $4.1 billion. A rebound in August brought them back to $19.1 billion. The recovery was timely: Without it, the dollar may have taken a serious hit, said Ashraf Laidi, chief currency analyst at MG Financial Group in New York, who headlined yesterday's client newsletter, "Foreign Central Banks Save Dollar From Disaster." . . .

The Chinese -- whose Treasury holdings have tripled since 2000, to $172 billion -- have already begun buying more euro-denominated assets, said Rebecca Patterson, a senior currency strategist at J.P. Morgan Chase & Co.

Earlier this year, both China and India diverted tens of billions of their dollar holdings to domestic projects, with China pumping $45 billion into its banks and India devoting $15 billion to infrastructure projects.

"China and India are no longer committed to open-ended dollar buying," Stephen S. Roach, chief economist at Morgan Stanley, warned clients yesterday. "At the margin this shift is negative for the dollar and for U.S. real interest rates."

As the big players begin to invest dollars domestically, the U.S. government is becoming more dependent on smaller nations, like Singapore and Korea, which may be quicker to sell off Treasurys and could demand higher interest rates, said Sung Won Sohn, chief economic officer at Wells Fargo Bank.

"The U.S. government will always be able to raise money -- well, at least in the foreseeable future," he said. "The question is, what will you have to pay and who will you get it from?" . . .

To John Williamson, a senior fellow at the Institute for International Economics, that is cold comfort. The Chinese and Japanese central banks may maintain their huge reserves for defensive reasons, he said, but a smaller player, like Brazil or Singapore, could try to unload its dollar reserves, triggering a global sell-off. Like a mouse in a circus, even a bit player could cause the elephants to stampede.

Wow. This news sent my heart into a bit of a flutter. And I'm not talking about the "I'm in love" kind of flutter, either.
The US dollar slid to fresh multi-month lows on Wednesday as the breaking of long-term trading ranges induced momentum traders to jump on board and triggered stop-losses.

The dollar fell to $1.26 against the euro for the first time since February, amid talk that Asian central banks had been selling dollars and buying the single currency, perhaps to reduce losses in the unlikely event of an imminent Chinese revaluation. . . .

. . . with the dollar finally having tumbled out of its well-worn trading range of between $1.18 and $1.25 to the euro, the selling was said to have been exacerbated by technical factors, with the triggering of stop-losses producing a cascade effect. . . .

Attention turned to what measures governments and central banks may take to stop unwanted currency appreciation against the dollar. There was talk of the Bank of Japan contacting banks to check on prices, seen by some as a possible precursor to intervention, although this report was not universally believed. Nevertheless, fears of Japanese intervention, combined with rising oil prices, were instrumental in limiting the yen to a 0.3 per cent gain to Y108.16 against the greenback.

The US fuel story just keeps getting uglier and uglier.
Crude-oil futures touched a record past $55 a barrel Wednesday after two key U.S. reports revealed declines in distillate and gasoline supplies for last week and showed that crude inventories remained below the year-ago level.

"It's a scary number for heating oil and ... refineries are suspected to be pulling from producing gasoline to increase heating-oil supplies," said John Person, head analyst at Infinity Brokerage Services. . . .

"This is supposed to be the time of year that heating supplies build in preparation for winter," said Todd Hultman, president of Dailyfutures.com, a commodity information provider. Instead, U.S. inventories of heating oil, which is part of the distillate stock figures, have dropped by almost 3 million barrels this month and are now 12 percent below year-ago levels, he said.

Demand for distillates remained above 4.2 million barrels per day for a second-straight week, according to Kloza. "Those are winter-like disappearance numbers, so the inventory count is clearly raising concern," he said, adding that on a four-week basis, distillate demand is up 4 percent from a year ago.

Summed up, "U.S. and world production are strained and it may be a very tough challenge to get through this winter without some large upward price spikes," Hultman said.
Private crude oil stocks have bounced off their mid-September low, but not by much. Crude stocks are lower now than they were in early September and 5.2% lower than this time last year.

And that's the good news. Gasoline stocks have been falling unevenly since July and are now 4.9% lower. They are particularly low on the East Coast (-9.0%), the Midwest (-8.2%) and the Rocky Mountain states (-13.1%). No wonder gasoline prices are up almost 20�/gal.

Finally, stocks of distillate fuel oil -- the stuff out of which home heating oil is made -- continue to plunge. They fell for the fifth week in a row last week and are now 7% lower than in early September. The situation is especially bad in the Midwest (-17.9%). Heating oil futures prices hit their nominal all-time high today of $1.565/gal. With this picture painted behind them, they've got nowhere to go but up.

But thankfully this isn't going to affect anybody's Christmas plans. The National Federation of Retailers says were going to spend $220bn on Christmas presents this year, +4.5% over 2003.

Yeah, I'll be getting my wife an extra 20 gallons of heating oil this year, tastefully gift-wrapped. Happy Holidays!

Tuesday, October 19, 2004

Checking in on the demise of the UK housing bubble . . .
House prices are falling at their steepest rate for nine years, prompting speculation that interest rates may have peaked. About 30 per cent more chartered surveyors reported a fall than a rise in house prices over the three months to September.

The Royal Institution of Chartered Surveyors (Rics) said the drop, the biggest since 1995 and the second consecutive [monthly] fall, was a reaction to the three hikes in interest rates over the summer. Inquiries from prospective purchasers were down for the fifth consecutive month and the number of unsold properties rose to its highest level for almost a year. . . .

The Ernst & Young ITEM Club forecast unit, which uses the Treasury's model, has said it does not believe there will be a housing crash. Rics echoed this, saying it was unlikely that the housing market would experience a deep or prolonged slump in prices in prices as long as the economy remained stable and people were confident about job security.
John Calverly of American Express isn't so sure, however.
It is hard to believe that house prices can rise faster than earnings for much longer. The ideal scenario would be for house prices to flatten out now in nominal terms, allowing the house price-earnings ratio to moderate over time as incomes grow.

The monetary policy committee would doubtless be ecstatic at this outcome. But, with the current ratio at about 5.5 times earnings, even a move down to 4, still well above the long term average, would require a 28% drop and take eight years at the present 4% rate of earnings growth. Markets tend not to be so well behaved.

More likely is that we will see a significant fall in house prices. The longer it is spread out, the more likely that earnings growth can take some of the strain of the adjustment. The Bank of England is moving very cautiously at present because consumer price inflation is under target and there is a good chance economic growth will remain solid for the next year at least.

In the longer term, we risk an economic shock of some sort, perhaps a new bout of consumer price inflation requiring the Bank of England to raise rates, or a US downturn. Then the housing bubble could be an accident waiting to happen.
If anything, the risks seem lower in the UK than the US. For you regular readers, you know I'm quite interested in the California housing bubble in particular. Some quick computations suggest California makes the UK look downright tepid.

In 2003, median household income in San Diego County was $49,886; in Los Angeles County it was $44,674; in Orange County, $60,118. Giving each the average national personal income gain from 2003:II to 2004:II of 5.2% puts their 2004 median household income at $52,480 for San Diego County; $46,997 for Los Angeles County; $63,244 for Orange County.

According to the National Association of Realtors, the median sales price of existing single-family homes in the San Diego metro area in 2004:II was $559,700; in the Los Angeles metro, $438,400; in Orange County, $655,300.

Thus my quick back-of-the-envelope number crunching suggests the housing price-earnings ratios in each area are:

San Diego . . . . . . .10.7:1
Orange County . . . 10.4:1
Los Angeles . . . . . . 9.3:1

Makes the term "bubblicious" wholly inadequate.

In comments yesterday, calmo asked a good (set of) question(s):
"Instead the real risk is that private capital starts pushing the dollar down, daring the central banks to rescue it."

What do you have in mind here? Heavy fx bets against the dollar? China and Japan are the central banks that are creating an artificially high dollar --the current rescue, no? The withdrawal of private capital would be met with further support from these 2 sources, no?
Except for a brief hiccup here and there, foreign central banks are indeed charging ahead in their tireless quest for dollars. They have net purchased US treasuries for 12 straight months and 22 of the last 23 months. Purchases were especially high in the first four months of 2004 when foreign central banks bought net $99bn in US treasuries. Much of that was thanks to the Bank of Japan which spent some �15 trillion to prop up the dollar, following on the �20 trillion spent in 2003 to do the same thing.

Thus as of August 2004, Japan was the #1 foreign holder of US treasuries, at $721.9bn. China (including Hong Kong) was a distant #2 at $221.7bn, and the UK in show position at $134.8bn.

The question most interesting to me now is not so much whether Japan and China are willing to prop up the dollar, but whether they are able to do so. In short, what is the ceiling on Japanese and Chinese currency intervention? Particularly (as suggested by the August data) if private capital is no longer an ally of the Asian central banks helping support the USD, but an adversary trying to push it down?

Back in early April The Economist was asking the same questions:
"THIS intervention is stupid," said Fumihiko Igarashi, an opposition politician in Japan�s lower house of parliament. "It�s a fight we can�t win." Indeed, on the day he spoke, Wednesday March 31st, the Japanese monetary authorities ceded one round in their fight with the currency traders. They watched the yen strengthen past �105 to the dollar, having intervened furiously in the markets only last month to keep it from crossing that threshold. The defeat became a rout as the yen pushed on to reach a four-year high, at �103.4 to the dollar. . . .
As it turns out, early April was the high point for the yen against the dollar, which is now worth around �109. Perhaps the BOJ really did defeat the currency traders. But at what cost?
Japan�s deflationary dilemma is the converse of this: not enough money, chasing too many goods. The Bank of Japan is doing its best to fix the first part of this problem, flooding the banking system with reserves. But as Andrew Smithers, an independent financial analyst, points out, this policy is fraught with difficulty, because one never really knows how much money is enough. The right amount will vary as the economy grows, and as the demand for money fluctuates. . . . In an ideal world, he says, the ministry would go on selling until the currency was thoroughly debauched and the economy decisively reflated.
This analysis suggests the Japanese appetite for USD may really be infinite. The end of Japanese deflation is the most likely dinner entree to satiate the Bank of Japan. As Smithers points out, Japan could use to reflate its economy, and printing trillions more yen is a way to do it. If inflation returns to Japan, printing infinite amounts of yen suddenly has domestic costs that the BOJ won't be willing to pay if currency traders decide to start pushing down the dollar. While the high price of oil is driving producer-level inflation in Japan, it still cannot break through into retail prices, mostly due to big wage cuts pressing down domestic demand. Something to watch.

For my $0.02, the real risk of being unable to support the dollar is located in China. While Japan's appetite while in deflation may be infinite, China's is not. Massive growth in the Chinese money supply and the incomplete sterilization of its reserve buildup means fuel for Chinese consumer inflation (which remains high), commodity inflation and asset bubbles. Just as deflation is acting as an appetizer for Japan, inflation will limit China's appetite in the face of currency traders determined to push the dollar down.

Also in comments, fatbear wondered whether a little rerun of petrodollar recycling might be in store. In the 1970s the oil producers, rich off of quadrulpled (and then octupled) oil prices, poured huge amounts of money into developing countries which then found themselves in a nasty debt crisis in the early 1980s when the oil market crashed and US interest rates went through the roof. If Japan and China decide to opt out of Bretton Woods 2, will OPEC be our new sugar daddy?

Certainly OPEC, which prices oil in dollars, doesn't want to see their (and our) currency take a spill. But are they rich enough to float our massive debt needs? As of August 2004 OPEC owns only $43.1bn in US treasuries, and so far they have put none of their oil windfall into propping up the dollar (in November 2003, at the start of the oil price rise trend, OPEC owned $42.8bn). Without the ability to print money with infinite reckless abandon, I don't think we can count on OPEC.

So, after all these paragraphs of analysis, let's hear three cheers for Japanese deflation!!

Monday, October 18, 2004

The US dollar fell today as the private capital flows supporting the sinkhole under the dollar drained out markedly in August.
The dollar slid to a new seven month low against the euro after data showed foreign appetite for US assets shrank in August to its weakest level this year.

The Treasury reported net foreign inflows into US securities totalled $59bn in August, down from $63.1bn in July, and the lowest monthly total since October last year. . . .

Inflows in the year to date totalled $594bn compared with a trade deficit of $394bn, but strategists warned this masked weakening inflows on a quarterly basis. The first three months of the year saw an average $85bn a month; this eased to $71.6bn in the second quarter, and to date, an average $61.5bn in the third quarter.

�This contrasts with the trade deficit, whose upward pace is outpacing net inflows,� warned Ashraf Laidi, chief currency strategist at MG Financial, who noted too that the ratio of inflows to the trade deficit (outflows) had fallen to 1.1 from 2.2 near the end of last year.

Strategists said the detail of yesterday's data added to market concerns about the dollar's vulnerability. . . .

"The important thing is how the inflows are made up," said David Bloom, currency analyst at HSBC. "Government sector flows were very high - the private sector does not want to fund the current account deficit at this price; it is politically funded."
Indeed. In August, central bank purchases were 38% of all foreign purchases of long-term US securities. For all of 2003 they were just 19%; over the last 12 months, 29%; over the last four months, 22%.

The numbers are downright ugly when it comes to US treasuries. Foreign offical sources and international institutions bought $19.7bn of them in August while foreign private sources sold $5.1bn. The was the worst evaluation of US treasuries by transnational capital since October 2003 when they sold net $7.3bn.

Private capital began fleeing US treasuries in 2000 and 2001. It came back in strength in 2003 and the first half of 2004, but that burst of favor might be fading, demonstrated by the rising percentage of treasuries bought by official sources mentioned two paragraphs up.

Always remember, of course, that one month does not a trend make. That being said, there is real fear again that the dollar might collapse. I don't think there is a genuine possibility that foreign central banks simply stop buying US t-bills, deciding against what some call "Bretton Woods II". Instead the real risk is that private capital starts pushing the dollar down, daring the central banks to rescue it.

This economy could start resembling the Jimmy Carter malaise days in more way than one.

I have a post up today at The American Street titled "Work harder, consume less, and answer to The Man in China, Japan and Europe who owns you". Fuel prices, trade deficits, deindustrialization and the dollar all wrapped up into one.

One of the few export bright spots for the United States is agriculture. Every year since 1962 the US has run an agricultural trade surplus. In order to pay for all those chemicals, clothing, lumber, electronics, oil, natural gas, furniture, steel, toys and cars (just a sample of the categories in which the US runs huge trade deficits), we export a hell of a lot of wheat, corn, soybeans, beef and chicken. So far this year the US has exported $39.4bn in agricultural commodities, over 7% of total US goods exports.

In the early 1970s ag exports became official US policy in an attempt to fight off the growing US current account deficit. From 1971 to to 1973 the US ag trade surplus grew 350% in real terms, and ever since, agricultural commodities have played an important role in trying to keep the current account deficit dyke from bursting.

True to form, however, even this bright spot is fading fast. August 2004 was the second time in the last three months that the US ran an agricultural trade deficit. Since late last year, US ag exports have been on a serious decline. $6.3bn in November (NSA) turned into $5.8bn in March which has shrunk to $4.2bn in August, the lowest monthly total in almost two years.

At the same time, ag imports are surging. Every month since October 2003 has seen ag imports of over $4bn. As a result, the ag trade surplus is dwindling. In 2003 it ran at $12.2bn, while through the first two-thirds of 2004 it is just $9.2bn and shrinking. At the pace it's on, the US is setting up for the smallest agricultural trade surplus in real terms since 1986. To get any lower is to go back to the pre-1973 era.

Of course, back in the mid-1980s the US current account deficit was "only" 3.4% of GDP. Now it is 5.7%. The elimination of yet another US export advantage can only spell greater and greater danger for the dollar, for US interest rates, and for a very hard landing in the future.

Friday, October 15, 2004

In constant 2000 dollars, the US trade balance (goods only) with China in 1998 stood at -$59.0bn. In 2003 it stood at nearly double that figure: -$117.0bn. In 2004 we're on track to easily surpass -$140bn in constant dollars (over $150bn in current dollars).

The essence of any such story is obviously that import growth is far exceeding export growth. Yet in 2004 it's not even that good. Since March 2004 US exports to China are actually falling ($9.0bn in the first quarter; $8.1bn over June-August) while imports streak ever skyward ($39.2bn in 2004:I; $52.6bn over June-August).

And anybody counting on the upwards revaluation of the Chinese renminbi to start solving this problem has Andy Xie to tell them that hope is not a plan.
Every couple of weeks the market becomes excited over the prospect of an imminent revaluation of China�s currency, the renminbi (Rmb). The prospect for such a scenario is extremely slim, in my view. Any change to China�s currency peg to the dollar could be the trigger that bursts China�s property bubble. The Chinese government has been extremely reluctant to take actions that might pop the bubble.
There are so many bubbles in this economy it's like a revival of the Lawrence Welk Show. In Xie's opinion, however, the Chinese bubble isn't material to the solution to the ballooning US current account deficit, because dollar devaluation isn't going to make much difference anyway.
The US deficit and strong dollar have been caused by the push factor; i.e., weak demand in the rest of the world is causing the US deficit. Devaluing the dollar may not work and is hard to do this time, in my view. . . .

When external factors are more important to the US deficit, dollar devaluation is hard to achieve and does not work. Even though the dollar has come down by 10% in the past two years, the US deficit has increased to 5.8% from 4.5% of GDP, because the weak dollar stimulated the US economy and increased oil prices. . . .

The US is trying to solve its deficit without going through a recession. Dollar devaluation is considered a painless way out; i.e., a free lunch.
Hope that consumer demand in East Asia and Europe dramatically (and quickly) explodes is not a plan, and hoping for USD devaluation isn't a plan either. Pressing the Chinese to revalue is a plan (with little apparent chance of success -- but I'm happy to be surprised) but might not make much difference in the end anyway.

History suggests that the only sure-fire solution to a massive CA deficit is recession. Xie recommends raising taxes as the only possible proactive strategy for the US, which will cut consumption, reduce the federal deficit and reduce capital export from Japan, China and the rest. Sounds like inducing a recession to me. Are the chances of such a scenario -- particularly under another four years of Bush -- any larger than a snowball's chance in hell?

The most likely outcome is muddling through for another 2-3 years, if possible. CA deficit at 7% of GDP, here we come!

Another wave of discounted car sales pulls the US retail sector's fat out of the fire in September.
A Commerce Department report on Friday showed U.S. retail sales rose by 1.5 percent in September, propelled by the sharpest jump in auto sales in nearly three years.

Wall Street had expected a 0.7 percent gain, following a revised 0.2 percent fall in August that was initially reported as a 0.3 percent decline.
As always, big incentives drove the auto retail numbers.
auto sales increased 4.2 percent last month, marking the biggest gain since the post-9/11 gain of 24.2 percent in October 2001.

As in that earlier month, automakers in September piled on the incentives to move inventories off dealers' lots. The carmakers earlier reported seasonally adjusted, annualized unit sales of 17.5 million in September.
As you can see from the following data, retail sales slowed markedly over the summer. From May to August, retail sales rose at an annualized clip of a mere 0.5%. Thus the big jump in September, contrary to earlier reports, is a notable turn-around.

Monthly growth in retail and food service sales (SA) for 2004:

January . . . . 0.5%
February . . . 1.0%
March . . . . . 2.1%
April . . . . . . -0.8%
May . . . . . . . 1.4%
June . . . . . . -0.7%
July . . . . . . . 0.8%
August . . . . -0.2%
September . . 1.5%

That being said, the retail sector is still clear on a "one on, one off" pattern. A big May was partly thanks to a sluggish April, and a big September is also surely due in part to a lackluster August. Two monthly gains in a row will speak loudly.

For the third quarter, retail sales grew an annualized 9.3% in nominal terms. This is a huge turn-around from the second quarter's nominal annualized -0.3% change. I guess I might just have to eat my words about US GDP growth in 2004:III. One suspects, however, that the US savings rate, which ticked up to 0.9% in 2004:II, will fall dramatically in the third quarter.

At least all those discounts and incentives will keep driving auto deflation.

Thursday, October 14, 2004

Barry Ritholtz over at The Big Picture has a great graph done by Professor Pollkatz on the relationship between US gasoline prices and Bush's approval rating. Suffice to say there is family resemblance.



I bring this up especially in the context of rising gasoline and heating oil prices. Regular gas is now up to $1.993/gal. nationally. This is the highest since the week of June 7, 15�/gal. higher than just a month ago, and only 7�/gal. below both the nominal all-time high (the week of May 24) and the highest real price in 18 years.

Combine this with distillate inventories, the fuel to make home heating oil, which are falling and thus prices are rising dramatically here as well.

As of October 8 the US has 120.9m barrels of distillate stocks. This time last year we had 129.8m. This is even more worrisome when one looks at the trends. In 2003 US distillate stocks rose steadily from April through December, exactly as one would hope and expect. Firms put distillate away in the warm summer and fall months, and then draw it down to produce heating oil in the winter. This year we see a truly troubling picture in which distillate stocks peaked in early September and have been falling steadily for a month now.

Stocks in the East Coast, the region most dependent on heating oil, are at the very low end of the average range now, and in the Gulf Coast region they've tumbled far below the average range. In response, NYMEX heating oil futures prices have skyrocketed, from $1.11/gal. in late August to a record $1.52/gal. today.

If Bush's popularity is tied to fuel prices even loosely, the Shrub is in real trouble. All the more reason to pay close attention to the Strategic Petroleum Reserve and the Northeast Heating Oil Reserve over the next two weeks.

Just when you thought it was safe to go back in the US current account waters. OK you never did think it was safe, but that big drop-off at around 1998 ft. is getting steeper and steeper.
The US trade deficit boomed to 54 billion dollars in August, the second biggest in history, as the country was swamped by high-priced oil and Chinese-made imports.

The total gap grew 6.9 percent from July to a seasonally adjusted 54.0 billion dollars in August -- one billion dollars short of the record posted two months earlier, the Commerce Department said Thursday.

The scale of the deterioration surprised analysts, who had expected a deficit of about 51.5 billion dollars.
Ah, it's always fun to point out how the "analysts" really don't know a damned thing. They were expecting a 2% rise in the monthly trade deficit and got handed a 7% jump instead.

The 2004 US economy is now the proud owner through eight months of the eight largest monthly trade deficits in history. The three largest deficits have occurred in the last three months. Monthly goods exports have been stagnant since April, and though exports overall are rising at a 13% clip on the year, imports are up 15%. The 2004 trade deficit is now a full 19% larger than last year's. "Strong and getting stronger", eh?

China alone is 24% of the US goods deficit. China and Japan together compose 36%. Well, at least we've filled their coffers with lots more dollars to loan us! Because we're going to need it. The 2004:I current account balance was -$147.2bn; 2004:II was -$166.2bn. With these numbers, the 2004:III balance could even sink below -$180bn.

Two quarters in a row of CA deficits well in excess of 5% of GDP will be pressing hard on the sustainability of this entire dysfunctional system. The Chinese are already having difficulty sterilizing its massive dollar inflows, the bigger they grow the more difficult it becomes. A larger money supply in China means more Chinese inflation, more/larger property bubbles and a larger and ever-growing threat of real collapse.

The Fed Governors started pushing the People's Bank of China on renminbi revaluation late last week. Now everything is quiet. Are we just whistling in the dark?

Wednesday, October 13, 2004

A rather slow economic news day, so here's some raw meat to keep you all happy.
Signals are growing that oil's price surge could push all the way to $70 a barrel, according to the technical analysts who forecast market trends by interpreting chart patterns.

Crude's 60 percent run-up this year to $50 record highs has been driven in part by fund investors who use chart signals to guide many of their big-money bets.

With prices now in uncharted territory, technical analysts say the blistering rally shows few signs of slowing and suggest prices could peak at $70 - nearly $20 above current prices. . . .

Phil Roberts at Barclays Capital said the longer NYMEX crude stayed above $47 a barrel the more likely it would become that the market was in the build up to a "classic commodity spike, suggesting $75 as a possible target."

All trend-following systems were positive, with no trend-ending patterns to lean against once the August high was breached, Roberts said.

"Against this backdrop we are wary of further near term gains and view dips as buying opportunities," he said. . . .

Analysts said downside risk was likely to be limited with Brent likely to find good support around $46 and NYMEX crude ahead of $50.

Fewer mortgate applications but more ARMs. This housing bubble is determined to live on until the bitter bitter end.
The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending October 8. The Market Composite Index of mortgage loan applications . . . decreased 9.2 percent compared with last week . . .

The MBA seasonally adjusted Purchase Index decreased by 4.9 percent . . .

The seasonally adjusted Refinance Index decreased by 14.2 percent . . .

The adjustable-rate mortgage (ARM) share of activity increased to 34.9 percent of total applications from 33.9 percent the previous week.

Tuesday, October 12, 2004

Two highlights from today's sneak peak at the IEA's latest Oil Market Report.
The global oil demand forecast has been raised by 240 kb/d for 2004, to 82.4 mb/d . . . World oil supply rose by 640 kb/d to 84.0 mb/d in September.
That means the world is currently consuming about 98% of production. A mighty thin margin indeed, especially considering in last month's Report the IEA estimated 2004:IV global oil demand at 83.8 million barrels per day.
Chinese demand growth shows signs of easing. Preliminary data suggest August growth slowed to 6%, from 12% in July and 25% in the second quarter. This reflected price effects, conservation measures and new non-oil power generation capacity.
So the Chinese are backing off oil. Good news for the global economy. They're replacing it with domestic coal burning ("non-oil power generation capacity"). Bad news for the global environment.

"Stagflation" is suddenly all the rage.

Case in point. A simple Lexis-Nexis search shows that from August 1999 through July 2004 the word "stagflation" appeared prominently (in the headline or lead paragraphs) in the Financial Times a mere 13 times. That comes out to an average of one appearance every 4.6 months. Since August 1, however, the word has appeared prominently nine times, on average one appearance every eight days. Today, in fact, the nasty word shows up twice. Clearly folks are gazing back to the 1970s and they don't like the comparisons.

From Joachim Fels in today's FT (sub. only):
I see five main parallels between the current situation and that of the 1970s. First, the world economy must again digest a sharp increase in oil prices. . . .

Second, just as in the 1970s, monetary policy has been highly expansionary . . .

Third, then and now, government budget deficits rose . . .

Fourth, the established industrialised nations in Europe and North America faced new competitors in world markets . . . [leading to] a big structural crisis . . .

Finally, just as global productivity growth slowed in the 1970s from its heady pace of the 1960s, we may now be at the tail-end of the information-technology-induced productivity growth cycle that began in the mid-1990s.
All very good observations. However, Fels omits the most important difference between the 1970s and the 2000s from his lineup, saving it for the final paragraph:
Yet, there is a big difference between now and the 1970s: workers now have less bargaining power. Back then, unemployment was lower, competition from emerging markets was less intense and the political climate following the student revolts of the late 1960s was more conducive to redistribution from capital to labour. Today, while wages are still likely to follow inflation with a lag, aggressive "autonomous" pay increases as in the 1970s are unlikely. Wage-induced cost-push inflation is not on the cards.
This is a very important difference. In the 1970s workers had the economic and the political capacity to drive up wages and thus demand and prices. Today things are quite different. As real wages have stagnated and even begun falling in the US, consumption in the US has been buoyed only through a rolling wealth effect, first rooted in equities and then housing. All of this, both in the US as well as in China, has been supported by extremely loose monetary policy which both countries are now in the process of tightening, however slowly and tentatively. Producers can try to raise prices, and on some goods and services (e.g. transportation) they will, but overall it seems unlikely that real 70s-style inflation will return precisely because of the prostrate position of labor today.

I wrote a couple of posts back in June on stagflation (here and here), based especially on some great work by Jonathan Nitzan at York University in Toronto. Jonathan emailed me back then with some of his more recent work, and I'll try my best to update my thinking in light of these mounting arguments for stagflation.

Nonetheless, I still remain committed to a basic deflationary scenario. After all, you wouldn't want me to start sending you "mixed messages," would you?

It appears the nervous inflation-Nellies in the UK have been overreacting -- disinflation is the name of the game in Britain as well.
A fall in the cost of transport services helped to push down the rate of UK inflation in September for the third successive month.

Figures released on Monday showed the Consumer Prices Index - the government�s target measure - fell by 0.2 per cent to 1.1 per cent, its lowest level since March. . . .

The drop surprised analysts who had expected the rate of inflation to remain unchanged following two consecutive falls in July and August.

It is now well below the government�s target of 2 per cent and Howard Archer, chief UK economist at Global Insight, said it would give the Bank of England additional scope to sit back for the rest of this year and further study the impact of its five interest rate hikes since November 2003 on the housing market and consumer spending.

Nevertheless, Mr Howard predicted that interest rates will rise a little further.
One interesting aspect of the British inflation picture is that the government's two basic inflation indices -- the Retail Price Index (RPI) and the Consumer Price Index (CPI) -- have been diverging notably since June.


The big difference between the two indices is that RPI includes mortgage interest payments while CPI does not. British CPI is now at 1.1%; the RPI minus mortgage interest payments is at 2.1% and that includes food and energy! Thus excluding rampant housing inflation, the UK is quite frankly flirting with general deflation.

Sound familiar?

Monday, October 11, 2004

Richard Berner and David Greenlaw of Morgan Stanley think 2004:III US GDP growth is going to turn out just peachy.
The economy has shown clear signs of rebounding from the spring �soft patch� in growth, and we now estimate that GDP advanced by 4.6% annualized in the quarter just ended.
Remember that 2004:II growth was 3.3% and 2004:I, 4.5%. This level of growth, in light of the mediocre retail sales figures for both July and September and a downright gloomy August, can only mean a quarter driven heavily by capital investment and housing. But capital investment to create products that no one will buy. And houses built for the most financially borderline homeowners financed by adjustable rate mortgages.

Still two-and-a-half weeks to wait for the advance numbers on third quarter GDP, but I'll be mighty shocked if it comes in at 4.6%.

Now that's a bubble-popping forecast.
[Housing] Prices in London fell 0.4% on the month, dragging the annual rate of increase to 6.5% from 8.4% in July. The ODPM said the average house price in August was just under �179,000, up from �177,500 in July.

Economists said the numbers confirmed their suspicions that the boom of recent years was over.

"With valuations at all-time record highs, confidence low and the full impact of higher interest rates yet to be seen, it seems likely to us that outright falls in average house prices, such as those seen in London in August, will become more widespread over the coming months," said Ed Stansfield of Capital Economics.

He predicted prices would fall 20% over the next three years.
Other reports out of the UK suggest that the Bank of England continues to fret over inflation at the producer level, and thus the signs are that interest rate hikes are not yet complete in Britain. It is roundly recognized that the last 25 basis point interest rate increase put the brakes on the runaway London housing bubble. Another 25 might just pop the thing.

The top two capital importers in the world today are the United States in the pole position (71.5% of global total) and, at a very distant second, the United Kingdom (4.5% of global total). Why are the US and the UK importing so much of the rest of the world's savings? In part because they don't have any of their own.
�57bn -- A report for the Government today identifies this figure as the total [annual] gap between how much people are saving and how much they need to save to ensure a comfortable retirement

[ed. -- about �1000 a year -- nearly $1800 at current exchange rates -- for every man, woman and child in Britain; for my family that would mean socking away an extra $9000 a year!; thank goodness for those employer contributions to my TIAA-CREF account . . .]

13m -- The number of British people not saving enough to provide for a secure retirement, almost half the 28m working population

On the American Street today, the General has a few words about the Bush administration claim that the US economy is "strong and getting stronger". Complete with a nice graph on real hourly wages of production workers under Bush.

You knew this was going to happen -- especially in Bush's America where 5.2 million more people are without health insurance, 4.3 million more are in poverty and the gap between rich and poor is pushing pre-New Deal levels. From today's WSJ:
With the nation's supply of influenza vaccine suddenly cut nearly in half by the shuttering of a British factory, signs of tension between those who have vaccine and those who don't are beginning to emerge.

Doctors, clinics and others who relied on Chiron Corp., whose U.S. shipment was derailed because of problems at its Liverpool plant, are urgently seeking help from those lucky enough to have ordered from the other big supplier, Aventis Pasteur Inc.

Meanwhile, some groups that aren't deemed by the government to be at "high risk" for serious complications from the flu -- including firefighters and the military -- are arguing for special consideration in getting vaccinated.

Executive Health Exams International, an upscale medical provider with a clinic in New York, is one of the haves -- and is giving shots even to young and healthy people, at $90 each. "We feel strongly about honoring our commitment to our patients who were already booked," said Nancy Boccuzzi, senior vice president of clinical affairs at Executive Health. The $90 price tag is the same as it has been for several years, said Ms. Boccuzzi. (A flu shot elsewhere generally is closer to $20.) . . .

"Every shot given to a nonpriority person is coming out of the arm of a person" in the high-risk groups, said Patrick Libbey, executive director of the National Association of County and City Health Officials.

"Social-equity issues are increasingly going to take center stage," said Matthew Cartter, epidemiology-program coordinator for the Connecticut Department of Public Health. . . .

Many public-health departments that were expecting to get Chiron vaccine now are counting on the willingness of private-sector providers to use supplies judiciously. Gov. John E. Baldacci of Maine asked businesses in his state to halt vaccination programs in order to reserve remaining supplies for high-risk people. All the flu vaccine in Connecticut belongs to the private sector, and long-term-care facilities and hospitals are among those without shots.
Here's a wrinkle you probably hadn't considered. It appears that the Department of Defense has also been burned by Chiron. The Pentagon ordered 2.5 million flu vaccines from Chiron, two-thirds of all the shots ordered from America's Big Two providers. Now it looks like the soldiers in Iraq and Afghanistan are going to go without as well.

Maybe they can beg some doses off the British units in Basra? Too bad the sick and old in America's nursing homes are not afforded even that luxury.

Perhaps the "bolt out of the blue" defense can earn the Bush administration a passing grade on 9/11, but the flu vaccine fiasco -- which is bound to result in the deaths of far more Americans than bin Laden ever killed -- cannot be passed off so easily. From today's Wall Street Journal (sub. only):
Federal regulators said an inspection of Chiron Corp.'s flu-vaccine plant in England last year turned up manufacturing problems similar to those that led British authorities to shut down the facility last week.

U.S. Food and Drug Administration officials documented what they called "deviations" from good manufacturing standards at Chiron's Liverpool plant in June 2003. John Taylor, the FDA's associate commissioner for regulatory affairs, said "systemic quality-control issues" led inspectors to conclude that Chiron wouldn't necessarily be able to discover problems, identify the root cause and take steps to prevent similar issues from arising again.

The FDA's disclosure suggests that there were early-warning signs about the problems that later led to the Liverpool facility's shutdown and the resulting shortage of influenza vaccine in the U.S. just as flu season is set to start. . . .

. . . in August of this year, Chiron reported that it found batches of vaccine contaminated with serratia, a common bacteria that, when injected, can cause bloodstream infections. The FDA asked for a complete investigation and began at least weekly conference calls with the company. Chiron reported that the contamination was limited to eight lots of flu vaccine, after tracing the contamination back to two pools of unfinished product, Mr. Taylor said. The company ultimately tested all the lots and re-tested those that didn't show contamination. Chiron "was still saying they'd be able to supply the U.S. market," Mr. Taylor said.

In a statement yesterday, the FDA said its vaccine branch never heard from Chiron that U.K. regulators were on the verge of blocking vaccine shipments. The FDA said "there had been no communication" between its vaccine regulators and their counterparts in England until after Chiron's license was suspended.
Still no account as to why the British saw the writing on the wall and lined up half a dozen suppliers for their flu season, while US officials felt confident in relying on simply two -- one of them with a pretty troubling track record.

Saturday, October 09, 2004

Since word first was released that the flu vaccine fiasco was hitting the US hard but the UK not at all, despite the fact that the vaccines in question were produced by a British firm in a British plant, I've been wondering how in the world this happened. How has the UK dodged a bullet while the US takes its full force?

The Washington Post has some very revealing information today.
Records at Britain's Department of Health show that the plant's owner, Chiron Corp., warned officials of the U.S. Food and Drug Administration and the British Medicines and Healthcare Products Regulatory Agency on Sept. 13 that potential contamination problems remained unresolved at the plant, according to Alison Langley, a senior spokeswoman at the department. . . .

Unlike the United States, health officials in Britain responded to the warning by making "plans by contacting other manufacturers," Langley said. . . .

Britain had been scheduled to receive about 2 million doses of the vaccine, known as Fluvirin, or 10 to 20 percent of its total need.

A British Department of Health statement said officials had already arranged for an additional 1.2 million doses from some of its five other suppliers by the end of the month, with an additional 1 million due to arrive by mid-November. . . .

"This plant has been well known in the industry," said a British pharmaceutical executive who spoke on condition of anonymity. "It's passed through a lot of companies' hands very quickly. . . . One or two companies who have owned this plant -- perhaps they haven't spent the money on it they should have done, while milking it pretty hard." . . .

British health experts said U.S. officials should have realized the potential scale of the plant's problems and taken steps to locate other suppliers.

"The American policy has been cruelly exposed -- their decision to put all their eggs in one basket, so to speak," said John Oxford, an international expert on influenza at Queen Mary's College in London. . . .

. . . Britain was wise to line up a half-dozen suppliers. . .
This sharp contrast between the UK and US only shows up the cynical opportunism practiced by the libertarian nutjobs at Truck and Barter who claim the problem is rooted in the government's refusal to allow pharmaceutical companies a big fat profit.

I can't believe this issue didn't come up in last night's presidential debate. However, it looks like Kerry is picking up the story in his stump speeches and had better bring it home in the third and final debate in Arizona. People are going to die this winter because of this idiotic mess, and Tommy Thompson -- and his boss -- have yet to face the music.

Friday, October 08, 2004

If China won't budge on renminbi revaluation, then the Fed Governors have decided the People's Bank of China needs a little shove.
Robert McTeer, the president of the Dallas Federal Reserve, set the ball rolling by warning that; �Over time, there is only one way for the dollar to go - lower�. Just for good measure, Mr McTeer also talked about potential problems for the dollar if and when the wider world stops funding the US current account deficit.

Fed governor Ben Bernanke waded in by stating that the Fed will pause in hiking interest rates if the US economy slows. It also emerged that President Bush spoke to his Chinese counterpart Hu Jintao about currency issues, including China�s plans to move to a more flexible exchange rate.

While numerous Fed officials have made similar comments before, the market was particularly struck by the tenor of Mr McTeer�s long-term warning.
If the Fed has decided to start pushing the dollar down after nine months of stubborn stability, it's time to start heading for the exits. Now the real skills are needed to bring the high-flying USD down for a soft landing, not a nose-dive death spiral.

I have a new post up this morning on The American Street about the Bush 43 jobs recession in light of today's profoundly underwhelming jobs numbers for September.

It's over there because they let me post cool charts.

Thursday, October 07, 2004

One more nail in the coffin of the "soft patch" set's analysis for the third quarter.
Consumers proved to be a frugal bunch in September as a heap of retailers delivered disappointing sales results and some warned that earnings were coming up short of expectations.

The sluggish results were widespread -- with some bright exceptions -- to seal a slowdown trend in consumer spending that began in June and goes beyond hurricanes on one coast and warm weather on another.

"The soft patch remains in place for the retail sector at this point," said Michael Niemira, chief economist for the International Council of Shopping Centers.

With 71 of the nation's largest chain stores reporting, Niemira said same-stores sales climbed 2.4 percent for the month. That's better than what he thought would happen as late as Tuesday, but the results are spotty and show a clear divide between the haves and have-nots. . . . At Thomson First Call, the final tally came in at 2.1 percent higher, below a final projection late Wednesday of 2.3 percent that had been trimmed a number of times throughout the month. . . .

. . . department stores were mostly dismal . . .
Monthly growth in retail and food service sales (SA) for 2004 thus far:

January . . . . 0.5%
February . . . . 1.0%
March . . . . . 2.1%
April . . . . . -0.8%
May . . . . . . 1.4%
June . . . . . -0.7%
July . . . . . . 0.8%

July '03 to July '04: 6.7%

As you can see, most of the retail sales growth over the last year came in 2003 and early 2004. Since March, annualized growth is just 2.1%.

The official August retail sales figures come out tomorrow, 9am. I expect that annualized rate will grow even smaller.

The General finally has found somebody with clout talking the talk of deflation. From Morgan Stanley's Andy Xie today:
I believe the global economy is headed toward either mild deflation or stagflation. If central banks cut interest rates in 2005 in response to slowing growth � an outcome of the oil shock � the global economy may be headed toward stagflation. If central banks focus on price stability and, hence, do not cut interest rate in 2005 despite slowing growth, the global economy could be headed toward low growth and low inflation with deflation in certain periods and some sectors.
Xie is particularly insightful in understanding that ultra-loose US monetary policy is built upon ultra-cheap manufactured goods from China. Persistent commodity deflation coming out of China -- not to mention the "dollar bloc" which lets US liquidity leak out of the US to East Asia -- allows the Fed to avoid the inflationary implications of its monetary policy.

That being said, Xie thinks China and East Asia writ large will be exporting inflation soon due to rising food and oil costs there.
Inflation in most economies is still restricted to food and energy. Financial markets do not expect inflation to spread beyond food and energy. The yield on US treasuries, for example, is negatively correlated with oil price at present; the market seems to believe that a rising oil price slows down the US economy and makes the Fed less likely to tighten and is not worried about the inflationary impact of rising oil prices.

I believe the complacency in the market may be misplaced. I see two reasons why inflation could spread beyond food and energy. First, the relocation of IT production to China may be coming to an end. The cost savings from the relocation have pushed the US import prices down but could be running out. This could signal the end of the downward trend in the US import prices for goods from Asia.
So which is it -- inflation (really, stagflation) or deflation? Xie parses the possibilities this way:
The balance between overcapacity and oil and food prices would determine if the global economy would feel deflationary or stagflationary.

The key to the outcome is how long the monetary bubble lasts and, hence, how high oil and food prices go. The longer the bubble lasts, the higher the oil and food prices would go, and the more likely the outcome is stagflationary. Even though oil and food prices would come down when the bubble bursts, their inflationary impact takes time to work into general prices.

Where oil prices peak out, therefore, would be a key to a stagflationary outcome. The bond market now appears to believe that higher oil prices are good for bonds, because it makes central banks less likely to raise interest rates. When high prices are high enough to cause a stagflationary outcome, the relationship between bonds and oil would reverse.
For my $0.02, Xie overestimates China's role as an inflation generator and underestimates the US as a generator of deflation in its own right.

First, while price indices for East Asian NIC imports have indeed risen since the depths of 2001-02, the annual inflation rate on all commodity imports from this region now stands at -0.7% and has been negative since 1996. Food production is indeed falling drastically short in China, but a revalued renminbi combined with rising consumption of US grain -- which itself has been falling dramatically in price since May -- should temper any serious food price rises.

Second, very strong US capital investment over the last year-and-a-half combined with newly flagging consumption growth and the continued failure of the market to produce a significant number of new jobs shows the US can generate its own deflation internally, as the most recent personal consumption expenditures price data shows.

The inability of either Japan or Germany -- the second- and third-largest economies in the world -- to generate internally driven economic growth or export inflation of their own only puts the exclamation point on.

Final score? Deflation defeats stagflation by 3.

Just as quickly as the Chinese took renminbi revaluation off the table, they put it back on again. Or, at least, that's what the rumor mill in East Asia is churning out.
a Korean newspaper, citing Chinese sources . . . claimed the renminbi would be re-valued by 7 per cent by widening its trading band against the dollar sometime around October 15, in order to choke off inflationary pressures in China.
Of course, this is only days after the Deputy Governor of the People�s Bank of China said concerning the schedule for revaluation, "China has an 8,000-year history, a decade is truly a short period".

Andy Mukherjee at Bloomberg thinks a slow-and-steady Fed tightening policy, not to mention the bond market's expected end to tightening later this year, makes revaluation even less likely.
According to Desmond Supple, the Singapore-based head of Asian research at Barclays Capital Inc., a big part of the $93 billion rise in China's reserves this year is due to speculative inflows ``linked to an expectation of yuan revaluation.'' Foreign direct investment into China this year is only $44 billion, and the country has actually posted a $217 million trade deficit.

Unless the Fed raises interest rates quickly and significantly, China may be reluctant to tinker with its currency policy as "adjusting the peg would not be seen as a one-off move but rather the start of a process, and hence could exacerbate the problem of capital inflows," Supple says. . . .

Although China has managed to decelerate money supply growth for four straight months, inflation is still at a seven-year high of 5.3 percent. With fixed-asset investment expanding 30 percent in the first eight months of 2004, the risk of overheating hasn't fully abated in the $1.4 trillion economy that grew at a scorching 9.6 percent pace in the second quarter.

At such a crucial time, China may not want to lose its tenuous grip on monetary policy by opening its doors even slightly to what could snowball into a self-fulfilling prophecy of currency appreciation. . . .

"The Chinese view appears to be `if it ain't broke, why fix it?'" Jim O'Neill, head of global economic research at Goldman Sachs Group Inc. in London, wrote in a report.

Finance Minister Jin Renqing and People's Bank of China Governor Zhou Xiaochuan may prefer to wait until inflation -- the cost of not doing anything -- becomes excessive.
The implication of course is that if China is successful at reigning in inflation through administrative measures (e.g. raising bank reserve requirements, using price controls, cancellation of government building projects), there may be no incentive for revaluation at all short of US tariff/quota threats.

Next time you're fueling up your car with that $2/gal. gasoline, remember the incredibly nasty work the guys in the oil fields do to make it all possible.

Wednesday, October 06, 2004

You have to give the man props for, if nothing else, his honesty. Give him an A for evilness, too.
An Israeli official close to Prime Minister Ariel Sharon created a political storm today when he said in a published interview that Israel wanted to pull out of the Gaza Strip unilaterally in order to freeze the so-called road map to peace with the Palestinians.

The aide, Dov Weissglas, spoke with confidence and the kind of bluntness that even Mr. Sharon has avoided showing in public.

His biggest allegation is that Mr. Sharon's effort to pull out of Gaza unilaterally mattered because it put off the establishment of a Palestinian state and had the support of the United States, an assertion that is likely to embarrass the Bush administration.
As long as Bush is president, we all know there will be not one step toward the creation of a Palestinian state and durable peace between Israel and Palestine. Under Kerry? I'm not a whole lot more optimistic, unfortunately. Maybe one step?