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Bernanke’s view on inflation, I think

Fed Chief Ben Bernanke did his first post-FOMC press conference yesterday. Predictably, he got a question about the impact of energy and food prices on the public and the whole issue of the impact of QE on inflation and the value of the dollar. There’s a lot of screaming and yelling about this subject in the press and among market participants. Bernanke held to his line, though, about inflation being low and these food and energy things being transitory, which annoyed a bunch of folks.

Here’s what I think Big Ben is reading the inflation situation. I’ll try to explain by way of example.

Imagine that you have $100 in your budget. Your housing (rent or mortgage) is $35. Food runs $25. Utilities and other expenses are another $25. Gasoline costs $15. Now let’s say gasoline prices double, so your cost goes to $30. What happens? If you cannot increase your income or borrow money you’ll have to cut $15 from among the other categories. That means your demand for other goods and services will go down.

Extend this example to the whole US economy. If income isn’t rising, then rising food and energy prices means money not available to spend on other things. That means less demand, and by extension lower prices in those sectors. What that tallies up to is no net change in overall prices. Even if income is rising, as long as it’s rising less rapidly than the increase in food and energy prices there will still be the dampening impact on prices elsewhere in the economy.

Below is a chart from the St. Louis Fed showing disposable income over the last 10 years. It show’s a year-over-year growth rate between 3% and 4% in the most recent figures. How does that compare to the change in food and energy prices? Just a fraction, right?

Of course, folks can borrow to make up the shortfall. Are they? To find out we need to look to the money supply figures.

Here’s the chart for the Monetary Base, which is the lowest level of money supply that is directly influenced by what the Fed does.

Again, we’re looking at year-over-year changes here. Notice the big spike up in 2008 when the Fed got aggressive about dealing with the financial crisis. In late 2009 and early 2010 we can see a spike up in the growth rate from QE1. The growth rate actually went negative in the latter part of 2010, though, before QE2, after which it has bounced back again.

The monetary base, however, does not reflect borrowed money. That’s in the bigger aggregates, especially M3. The Fed stopped publishing M3 a few years back, but we can see a continuation version created by the folks at ShadowStats.

Notice in the chart how the y/y change in M3 has been negative since late 2009 or early 2010. That basically means the amount of debt outstanding has been falling. In other words, folks in the US have not been borrowing to finance purchases beyond their income. Quite the opposite. They’ve been reducing debt (though write-offs are a factor here).

So what we have is income not rising at the same pace as increases in food and energy prices and debt shrinking, not expanding. That means there’s less money available to be spent on other goods and services. That is helping to depress prices in those sectors, which is why Bernanke is not worried about general inflation yet, but does have concerns about economic growth. At least that’s how I think he’s viewing things.

Trading Book Reviews

Book Review: The Great Deleveraging

[easyazon-link asin=”0132358107″][/easyazon-link]”Capital preservation should be goal number one” is the final line in [easyazon-link asin=”0132358107″]The Great Deleveraging[/easyazon-link] by Chip Dickson and Oded Shenkar. That’s the conclusion provided to finish off about 300 pages worth of discussion, data, and analysis related to economic and stock market patterns of the last century or so. The authors take the reader through extensive historical study of how the US and global economies have changed and evolved and how stock markets have reacted to those changes in their bull and bear market cycles. They do so in a very easy to read fashion, however, with loads of charts and graphs to make their points. It is, in many ways, a quick read for all its length and content.

My one gripe about this book is that the subject matter noted in the title doesn’t really get all that much coverage in a direct fashion. The first chapter is titled “The Great Leveraging”, which makes sense since you have to lever up before you can delever. The chapter with the same name as the book’s title doesn’t come until the tenth (of twelve), though. In between there are chapters reviewing the history of real asset returns, global growth, and stock market patterns. Chapters on emerging markets and developments in the private sector are tossed in as well, some of the content of which only seems loosely related to the main discussion.

After all that, I’d like to have seen a more of a forward projection as to what The Great Deleveraging could look like, especially since the book seems to intended to give the reader something practical to apply. That stuff comes through in the final two chapters. The penultimate provides ways to gauge the economy and markets. The final chapter could be reasonably described as laying out a high level, fairly conservative plan for your financial future.

As much as I’m a bit disappointed that there isn’t as much meat to the deleveraging discussion as I’d have liked, I still give the book a solid overall score. There’s loads of very interesting information and suggestions of the sorts of things you can use to develop expectations for how the financial markets will perform given likely economic developments. Definitely something traders and investors whole like to take a fundamental view on things will find worthwhile.

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Trading Book Reviews

Book Review: Capital Offense

[easyazon-link asin=”0470520671″][/easyazon-link]Another of the genre of books about the causes of the financial crisis that’s been been released of late is [easyazon-link asin=”0470520671″]Capital Offense[/easyazon-link] by Michael Hirsh, which I’ve recently finished reading. This is a book that focuses more on the broad array of personalities than the others I’ve read – in particular on the leading policy makers of the last couple decades. The authors primary cast of characters includes Milton Friedman, Alan Greenspan, Robert Rubin, Larry Summers, Joseph Stiglitz, with copious biographical information included for all of them.

I will readily admit that I’ve not been a student of economic history and as such don’t really know all that much about the individuals who have shaped it over the years. One of the things I found most interesting about this book was the discussion of how the economic philosophies of Milton Friedman and Alan Greenspan were developed and shaped.

The basic theme of Capital Offense is the growth then dominance of free market thinking in US and global policy making, starting most powerfully in the Reagan era and progressing right through the intervening administrations and into the Obama presidency. Hirsh points to Friedman as the leading initial force of this movement, but seems to be hesitant about actually blaming him for what he calls the free market zeitgeist that created the financial crisis. He is not, however, shy about placing that blame firmly on Alan Greenspan, Robert Rubin, and Larry Summers for their attitudes to regulation and actions to reduce its impact on the markets.

Interestingly, Stiglitz is portrayed as the hero of the period because he had it right in terms of seeing what was to come, but was generally marginalized when it came to actually being a part of the policy mechanism. My one little issue with that is the implication he’d have been able to get the policy right given the opportunity. Maybe he could have done. We just don’t know.

The author leaves us with a critical view of the Obama administration in how it features many of the same individuals who were integral in the way the free market mantra was so entrenched during the Clinton administration and how it’s missed opportunities to enact needed change to the financial system. He doesn’t leave the reader feeling very positive about future prospects.

Overall, I found Capital Offense a very informative and engaging read. I definitely recommend it to anyone looking to get a look at the underlying economic philosophies which brought us to the current point.

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Trading Book Reviews

Book Review: On the Brink by Hank Paulson

[easyazon-link asin=”0446561932″][/easyazon-link]I was asked earlier in the academic term if I would act as a 3rd-party reviewer of an independent study project being done by a student at the University of Rhode Island. The project has as its core former US Treasury Secretary Hank Paulson’s book [easyazon-link asin=”0446561932″]On the Brink[/easyazon-link]. Figuring that I probably should know what Mr. Paulson said prior to making any comment or reaction to the student’s project, I’ve gone ahead and given the book a read. Since it’s something very market-related, I figure it might be of interest to readers of this blog, so here are my thoughts.

[easyazon-link asin=”0446561932″]On the Brink[/easyazon-link] is basically a diary of Paulson’s time as Treasury Secretary, which ran from 2006 to 2008. That, of course, encompasses the most dramatic period of the financial crisis, running from when things started coming unglued in 2007 to the point at the end of the Bush administration when the financial markets were just about finally stabilized. The book details the sequence of events which covers the Bear Stearns take-over, the Lehman collapse, the receivership of Fannie Mae and Freddie Mac, the AIG bailout, TARP and just about everything in between.

This is NOT a history of the financial crisis. Paulson doesn’t really get into the “How did we get here?” in any dedicated or focused fashion (for something more along those lines you may want to read Financial Shock by Mark Zandi). This book is Paulson telling the story of how Treasury, the Fed, the FDIC, the SEC, Congress, the President and others worked together to try to resolve the problems facing the financial markets during the time frame in question from his perspective. As such, one may be inclined to think of it as an individual trying to establish his legacy. Perhaps it is, but I also found it to be a very honest telling. The book doesn’t shy away from Paulson’s insecurity at different points, or the impact the long hours and intense stress had. I didn’t come away from the book thinking Paulson had portrayed himself as the hero of the tale. If anything, he spends considerable time talking about the tireless work of the numerous people involved.

From a reading perspective, I found the book well-paced and fairly easy to get through in general terms. I think Paulson does a very good job of reflecting the uncertainty and rapid development of events during the time span in question. He also presents an interesting view of some of the major political movers of the time, many of whom are still involved in things today. We in the public don’t often get that sort of thing, as we mostly see the made-for-TV moments of press events and committee testimony.

On the negative side, my guess is that some subjects might trip up the reader who isn’t familiar with the deeper elements of the financial markets. The book could have probably done with explanations at a few points to make things more clear for the lay person – like why short selling was so bad, why AIG was bleeding cash, etc. The lack of such explanations does not detract from the main narrative, but no doubt some readers would find them useful in helping understand why things were the way they were.

Overall, I think [easyazon-link asin=”0446561932″]On the Brink[/easyazon-link] is a very worthwhile read for those interested in understanding how things developed and progressed during the financial crisis.

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Trading Book Reviews

Book Review: The Power of Gold

[easyazon-link asin=”0471003786″]The Power of Gold[/easyazon-link]I just completed a book entitled [easyazon-link asin=”0471003786″]The Power of Gold: The History of an Obsession[/easyazon-link]. It was lent to me by a colleague at work. He and I talk monetary policy on a fairly regular basis, so he thought I’d like to give this book a read.

In brief, this is a book which tracks the use of gold from a monetary perspective through most of human civilization. If you’re at all interested in history, then this book is definitely right up your alley. It takes a look at world events from a perspective that you won’t find in many other sources. Primarily that means focusing on how gold was (or was not) the main focal point of money and trade. I personally didn’t care for the author’s occasional forays into discussions of the decor of various palaces and whatnot, but they weren’t too distracting. Beyond that, it was a very well written book, and a pleasant read.

The really interesting stuff from a trading perspective, of course, is the latter part of the book where it gets to modern times. I personally found the whole discussion of the 20th century, which was probably the last third or more of the book, to be the most meaningful. The author really presents an excellent discussion of various perspectives and efforts related to different countries being on or off the gold standard and how that all played out in both domestic and global economies. Even the technicians out there could find this a really interesting book, if not really something which will contribute much to their trading strategies.

One of the things which has come up in modern political, social, and economic discussions is the idea of going back on the gold standard. There have been some very prominent proponents. If you want to get an idea of what that might look like, how that might play out in the global trade and economic modern environment,  you’ll definitely want to give [easyazon-link asin=”0471003786″]The Power of Gold[/easyazon-link] a read. It will really have you thinking about the complexity of it all, and the implications.