Monthly Archives: February 2007

The Bottom

Today’s New York Times front page (look at the top of the right-hand column):

Expect the market to move up very shortly.

The Market Collapse

Everywhere I look and everything I hear suggests that the huge market sell-off today is because of the fall in China’s stock markets. I have a hard time believing that this is the case and — finally — I am not alone. David Gaffen of WSJ’s MarketBeat writes:

This isn’t just China, folks. Every major index, at one point, had lost at least 4%, and the Dow industrials jumped from a 260-point decline to a 460-point decline in the blink of an eye.

He also highlights a quote from our friend Barry Ritholtz:

“If you want to believe that some bureaucrat in China changing the margin requirements for local speculators as the cause of the US selloff, then go ahead,” says Barry Ritholtz, in a comment today. “Me? I prefer to believe what is right before my eyes: Decaying economic fundamentals, a complacent market that is overbought and way overdue for a correction.

Barry has more excellent analysis here.

I think that Barry is dead-on, but I would add something else. Growth is slowing — not in my mind towards a recession, but slowing nevertheless. In addition, inflation is higher than the Fed would like it to be. These two factors are at odds. The uncertainty regarding the Fed only led to a greater uncertainty in the market and thus extended the sell-off (to some degree).

Critics will argue that the Fed Funds futures contracts headed higher, estimating that there is around a 68% chance of a rate cut, and thus the market does have an idea about the Fed. This increase, in my mind, is a byproduct of the selling rather than a forecast. I will be interested to see where this probability settles in the coming days.

Nevertheless, the fact remains, the cause of the decline was not China.

Quote of the Day

“I read something today that all but pushed me into the Bullish camp, nearly cancelled my recession forecast, and almost made me revise my market prediction to Dow 16,000: Former Federal Reserve Chair Alan Greenspan warned that the U.S. economy might slip into recession by the end of the year.”

Barry Ritholtz

Market Myths

Tom Palmer on market myths.

HT: Marginal Revolution

Playing with Numbers

This week’s Economic View column in The New York Times opines:

FOR more than a decade, many American economists have pointed to Europe and Japan as prima facie evidence that layoffs in the United States are a good thing. The economies in those countries were not nearly as robust as this country’s. And the reason? Too much job security in Europe and Japan, the economists said.

American employers, in sharp contrast, have operated with much more “flexibility.” Hiring and firing at will, they shift labor from where it is not needed to where it is needed. If Eastman Kodak is struggling to establish itself in digital photography, then Kodak downsizes and labor moves to industries and companies that are thriving — software, for example, or health care, or Wal-Mart Stores or Caterpillar.

This shuffling out of one job and into another shows up in the statistics as nearly full employment. Never mind that the shuffling does not work as efficiently as the description implies or that many of the laid-off workers find themselves earning less in their next jobs, an income roller coaster that is absent in Europe and Japan. A dynamic economy leaves no alternative, or so the reasoning goes among mainstream economists.

[...]

Starting in the mid-1990s, Europe and Japan did wallow in recession or weak growth while the American economy expanded at a spectacular clip. But no longer. Growth is slowing in the United States just as it speeds up in the 25-nation European Union and in Japan. Unemployment rates in those countries are also beginning to come down, suggesting that the American system is not the only route to full employment. [Emphasis added.]

Okay, let’s compare unemployment rates from 2006:

  • United States — 4.7%
  • European Union — 8.5%

This hardly represents a closing of the gap. It also does not lend credence to the claim that the “job security” policies are what lead to full employment. Of course, after arguing otherwise, the author acknowledges this:

As the gaps close, does that mean that job security, in the European and Japanese style, is the right way to go after all? The question would be easier to answer if the European Union countries and Japan had stuck to their orthodox job security. They have not. On their way to revival, they adopted some of America’s practices. [Emphasis Added.]

Essentially, my problem is with the author’s view of the economic landscape. He later writes:

But now Japan is in the fifth year of an ever-stronger recovery, and this year, according to some forecasts, growth in the European Union may even exceed that in the United States, where the economy may be weakening in the sixth year of a recovery.

The United States is in an economic expansion, not a recovery. Nevertheless, the author presents information in a way to suggest that the European Union and Japan are consistently outpacing the United States; they are not.

Doom and gloom. What else should I expect from the Times.

Ritholtz on Gold

As many of you know, I have recently been professing my belief that inflation is still too high (see here and here). Today, I would like to highlight this stellar piece of writing by our friend Barry Ritholtz:

A grudge match of epic proportions has been developing. Like Ali and Frazier, these two pugilists have been taunting each other, name calling, daring their counterpart to step into the ring and get the beating they so richly deserve.

This championship match, the Thrilla in Manilla, the Rumble in the Jungle can no longer be avoided. The contestants are fit and well-trained, the crowd is growing restless, the bets have been placed. Let the battle begin!

In this corner, weighing 195 pounds, standing 5 foot 10, hailing from Washington D.C. via Harvard, MIT and Princeton, New Jersey, wearing the M1 green trunks, the Charlemagne of Currency, the prince of paper, the bearded bard of the Fed, monarch of monetary policy, Benjamin GOLDILOCKS Bernanke!

And in the opposing corner, weighing 2046 metric tonnes — one ounce at a time — the shiny, precious, storehouse of value, the standard for monetary exchange, the most malleable and ductile of the known metals, that master of disaster, hailing from most of the world, that dense, soft, shiny, yellow metal, GOLD.

The battle between these two titans has become increasingly loud and volatile as of late. Bernanke, a former inflation Hawk, recently went all Lovey Dovey: He now believes there is “growth with ebbing inflationary pressures and a stabilizing housing market.”

When Gold heard this, it laughed out loud, calling the Fed Chair out for such nonsense.

[...]

Gold futures edged higher earlier today, as rising crude-oil prices and a weaker dollar underpinned demand for the precious metal. Marketwatch reported that Gold for April delivery was last up $1.50 at $684.50 an ounce on the New York Merc. On Wedsday, gold closed at $684 an ounce, a seven-month high.

And the Fed? They are content to jawbone the markets.

All the while, Gold sits there, smiling.

I am not as concerned as Barry about the “subprime implosion”, but he is dead right on inflation.

Read the whole thing; it’s both entertaining and insightful.

Beware Economic Nationalism

The WSJ’s Washington Wire blog highlights the thoughts of UAW President Ron Gettelfinger:

Domestic auto makers and the United Auto Workers often butt heads when it comes to job cuts and health-care costs. But they agree on one thing: Detroit doesn’t get the love it deserves from the White House.

Hefty health-care and pension costs are often cited as financial shackles for the Big Three that foreign car makers like Toyota don’t have to contend with. But UAW President Ron Gettelfinger, speaking last night at a forum on workplace diversity at the University of Michigan-Dearborn, said: “The union’s aren’t the problem. You’ve got a president of the United States who wouldn’t even come here to discuss the problem.”

President Bush met with the chief executives of General Motors Corp., Ford Motor Co. and the Chrysler Group at the White House in January to discuss industry challenges. But nothing came of the visit in terms of legislation or policy.

Nothing came of their meeting? In the president’s State of the Union address, he unveiled plans to curb gold-plated health care plans. This would disproportionately help the U.S. auto manufacturers, whose employees — and retirees — have top-notch health care plans.

Nevertheless, Gettelfinger’s imploring of the president to do something is revealed to be no more than a call for protectionism:

“We believe in trade — we believe in fair trade,” he said. “We don’t believe in free trade where we come up on the short end of the stick.” Gettelfinger rattled off statistics of foreign nameplate market share in other countries: 2% in South Korea, 5% in Japan and 22% in Europe. In the U.S., foreign auto makers have about 40% of the market. Referring to U.S. trade policy, he said, “The working-class people are not represented in any of these trade discussions.”

First, I would hardly call the high-wage auto workers “working class”. Second, Gettelfinger is clearly illustrating one of Milton Friedman’s famous anecdotes:

Businessmen want freedom for all other people, only not for themselves. Then they want various subsidies, tariffs, privileges, etc.

GM and Chrysler

The Wall Street Journal reports:

But any Chrysler buyer also would inherit the troubles plaguing Detroit — and GM already has its share. David Cole, president of the Center for Automotive Research in Ann Arbor, Mich., said a GM takeover of Chrysler “would be a stretch.” In a Feb. 20 report, Goldman Sachs Group Inc. called the idea “illogical.”

Nevertheless, people familiar with the matter said GM has had discussions about buying Chrysler and hasn’t ruled out the idea. The two companies also are considering working together under a less intensive relationship in a few specific areas, such as sport-utility vehicles and minivans, these people said.

GM has made progress in the past year on streamlining its global operations and cutting costs, an effort that could be knocked off course if management has to focus on integrating and righting an unprofitable operation such as Chrysler, said Mr. Nesvold. “Right now, GM’s objective is to make its business less complex, not more complex,” he said.

Analysts say GM could gain advantages from buying Chrysler. A purchase would eliminate a direct competitor from GM’s biggest market. Chrysler’s Jeep brand could be a nice complement to GM’s Hummer. Chrysler is also strong in minivans, a segment GM has left.

A deal might also give GM the additional leverage to negotiate health-care cuts with the United Auto Workers union. Both GM and Chrysler are obligated to set aside billions of dollars to pay for pensions and health-care coverage for workers, retirees and their dependents. By taking over Chrysler and threatening to close Chrysler plants, GM might be able to push the union to accept cuts that would lower the health-care liabilities.

“That’s the one big carrot I can see,” Mr. Cole said.

I really do not see the upside to this possible purchase. General Motors has begun its restructuring and from what I hear, it has been successful thus far. Purchasing another struggling company with the exact same problems seems like a step in the wrong direction.

Goldilocks? Not likely

If you recall, I recently highlighted the reacceleration of M2 growth:

…M2 reaccelerated in 2006 and is trending higher. This likely means a higher, not lower, Fed Funds rate in the future.

Nevertheless, many have been heralding the “Goldilocks” economy of low, stable inflation and growth around potential. The latest inflation data, however, suggests that Goldilocks is a fairy tale, both in literature and in reality. The Wall Street Journal reports:

The consumer price index rose 0.2%, the Labor Department said Wednesday. The CPI increased 0.4% in December. Core inflation, which is consumer prices excluding food and energy costs, increased by 0.3%, after rising 0.1% during each of the three previous months.

[...]

Core prices rose 2.7% in the 12 months ending in January 2007.

Bernanke is not likely to see 2.7% as a low rate of inflation. I still believe that the next move in the Fed Funds rate is higher.

Barney Frank v. Inflation targeting

The Financial Times reports:

It would be a “terrible mistake” for the Federal Reserve to adopt any form of inflation target to guide its interest rate decisions, Barney Frank, the Democratic chairman of the House financial services committee, has told the Financial Times.

Mr Frank, whose committee is one of two in Congress charged with oversight of the US central bank, said such a target “would come at the expense of equal consideration of the other main goal, that is employment”.

Personally, I am intrigued by an explicit inflation target as presented in Inflation Targeting (Bernanke, et al.).

I would like an explicit inflation target for the very same reason that Frank opposes it. The Phillips Curve is dead. The long-run trend of employment is not influenced by money growth. In the long-run, more money equals more inflation. A low, stable rate of inflation will allow for growth and employment closer to the long-run trend.