Please Don't While They Fiddle About

Twisting by the Pool



I economic data has been lackluster (I am being kind), European leaders are in denial and the Fed has taken dancing lessons.

The economy is slowing. Is any one really surprised? With food and fuel prices elevated going into the third quarter, how in the world did anyone believe that consumers would keep on spending? When prices of goods with inelastic demand curves rise, consumers must make choices, if incomes were rising the situation might be different, but with employment in the dumps, wage growth is just not happening.

Some thought it was just a matter of time before companies making handsome profits exporting affordable goods (thanks to the weak U.S. dollar) would hire workers. However, few pundits were paying attention to new factories going up overseas or the cheap financing paying for new equipment and more efficient processes here in the U.S. Machines are cheaper than humans.

What will these pundits say now that the U.S. dollar has rallied against most major currencies? The one blessing is that the consumption tax on households has been reduced as lower food and energy prices, resulting from the stronger dollar, could put discretionary cash in the hands of consumers. Worst case is that households can delever (pay off debts) more quickly. Speaking of taxes, will somebody tell the President that we tax and spend too much and that temporary stimulus does a better job encouraging consumers to save or pay existing debts rather than spend? How are consumers to make large purchases, such as an automobile, when the extra cash in their budget lasts for a year and their loan is for five years? We won’t even the discuss the folly of limiting the tax benefit of municipal bonds and creating infrastructure banks. I am not even sure if the Federal Government has the power to tax municipal bonds used to fund essential services and projects.

Then there is the Fed. I come here to praise Mr. Bernanke, not to bury him. It is thanks to him that we have avoided recession as the President and Congress fiddle while America burns (Roman enough for you? Yeah, yeah I am mixing Nero and Julius Caesar, but cut me some slack). Seriously, the Fed is supposed to foster full employment and price stability. It is not supposed to keep the economy growing while the executive and legislative branches of the government bicker and pursue their own interests. However, this is exactly what has happened for the past two decades. Please stop looking for the Fed to solve all problems. The problems are structural, fiscal and not monetary. When will that penetrate the thick skulls of politicians, pundits, market participants and consumers?!!!!!!!!

Meanwhile all the Fed can do is dance, dance, dance, dance to keep the economy out of recession. Mr. Bernanke had better have his dancing legs ready because it looks like fiddling time in DC.

Cauliflower Power

According to today’s Nonfarm Payrolls Report, the U.S. economy added no, nil, nada, zero jobs in the month of August. Nonfarm Payrolls data for July and June were revised lower by a combined 56,000 jobs. Although it is true that the strike at Verizon contributed to the majority of the 48,000 jobs lost in the information sector, adding back each and every lost communications job would have resulted in a print of 48,000 new jobs. Pundits should stop trying to spin the economic data.


The truth is that the economy, which had only gained limited traction since the recession ended two years ago, is sputtering. Politicians, pundits and the American people should stop looking to the Fed for solutions. The Fed has done almost all it can do. QE3 will be like pushing on a string. The best it can do is to “twist” and move its bond holdings farther out on the yield curve (10-year or so) to have a direct effect on driving down mortgage rates. The Fed can also set inflation, growth and employment targets to instill confidence among capital market participants. All of this is well and good, but these are cyclical tools to remedy cyclical problems. The troubles facing the U.S. economy are of a structural nature.

The problems facing the U.S. economy are:

1) Too many homes and too few qualified buyers. Not all of it is due to exceptionally tight lending standards. There are far too many homes even if banks adhered to any kind of prudent lending standard.


2) U.S Households are overleveraged. Just as a person must work through a hangover after a long weekend of partying and alcoholic imbibing, U.S households must endure a period of pain as they correct imbalances on their personal balances sheets. The idea of curing too much debt by having consumers incur more debt is nonsensical and irresponsible.


3) The U.S. offers businesses very few comparative advantages versus their global competitors. The U.S. has the second highest corporate tax in the free world. On economically-stagnant Japan has a higher corporate tax rate. U.S. businesses are reluctant to repatriate dollars earned overseas. Instead money is held, spent and invested overseas. Production occurs close to local customers as well. The actions taken by the National Labor Relations Board attempting to block Boeing from opening a factory in low-tax, non-union South Carolina demonstrates how anti-business or current crop of policymakers really are.


This is not about political ideology or social justice, it is about a malfunctioning alleged market economy that has been hamstrung for far too long by nonsensical, albeit well-intentioned, government policies the negative effects of which have been offset by Fed policy since the early 1990s. The Fed can do no more. It is time for policymakers to hold their collective noses and eat the cauliflower that are economically-friendly policies to get the growth engine running.

Bond investors may have read articles this week, one from Bloomberg News and one in the Wall Street Journal, which espoused the opinion that the bond market held a positive outlook for the economy because the yield curve (between its short-term and long-term benchmarks, the two-year and 10-year treasury notes was positively-sloped by a fairly sleep 200 or so basis points. The articles each stated, correctly, that the U.S. economy has never fallen into recession when the yield curve was positively sloped and that the curve flattens or inverts before that happened.

At the risk of insulting the intelligence of the two respective authors, are they kidding? The Fed has the Fed Funds rate at effectively zero. Since Fed monetary policy rules the short end of the yield curve, the two year note is anchored below 20 basis points. However, the 10-year is beyond the Fed’s influence. Ten-year yields respond to growth and inflation expectations. A 10-year treasury yield in the low 2.00% area reflects very poor growth. We could see it dip below 2.00% and remain there for an extended period of time if and when the Fed begins reallocating its holdings farther on the curve. However, because of extremely low short-term rates, the yield curve cannot go flat or invert.

The yield curve is about the journey, not the destination, especially in this environment. The fact that, prior to today, the curve between two-years and 10-years had flattened by approximately 70 basis points since the end of June is a more accurate indicator of the bond market’s sentiments regarding the U.S. economy.

The September 20th – 21st FOMC meeting should be interesting. Following today’s employment data we are likely to see one hawk, Minnesota Fed President Narayana Kocherlakota, defect to the doves. However, I do not believe we will see a full-blown QE3. The Fed is more likely to set targets (jawboning), either hard or soft, and announce that it is going to perform extension swaps farther out on the yield curve.

With commodity inflation already elevated and blamed for much of the slowdown in consumer demand and for hampering job creation, aggressive easing could be death for the U.S. economy with the holidays and winter’s cold just months away.

I would wish everyone a happy labor day, but these are not very happy times for labor in the U.S.