Archives for August 2009

Recession 101

Well, this week I just got back from vacation. We stayed in a cabin at Brown County State Park in Indiana. Twas a great time and really enjoyed the beauty of God’s creation, and of course, spending some quality time with my wife and two daughters. My sister, her husband, and my parents joined us then toward the end of the week. Great times!

Well, it took 4 hours to drive there, and with a 3 year and 1 year old in the back seat of the van, you can imagine the fun. So as I stared out the window peering thru the tons of “Putting America Back to Work” road signs and other billboards, one sign stood out:

Recession 101: CHILL!

Hysteria only makes it worse.

That was it, and it made sense to me. Now that I’m back and catching up on reading, there are quite a few well respected economists that are declaring the recession is close to being over. Let’s hope!

What do you think? Are you seeing signs of recovery in your neck of the woods? Is the recession over? Feel free to post a comment.


Warren Buffett Says Inflation is a Real Threat

The New York Times published an article by Warren Buffett yesterday.  He touches on a couple of subjects that we’ve written about recently:

  • our country’s debt, and
  • the threat of higher inflation

Warren commends both the Bush and Obama administrations for their courageous actions last fall which helped us avoid a depression.  With the US economy now a slow path to recovery, we now face the side effects of “a gusher of federal money” that played “an essential role in the rescue.” Although it may be a long time before these effects are visible, “their threat may be as ominous as that posed by the financial crisis itself.”  So what are the side effects Warren’s talking about? Gigantic deficits and inflation.

“To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.”

Our government is spending our nation into a mountain of debt.  So how do we finance this increase in debt? Warren points out three ways:

  1. Borrow from foreigners.  Foreigners already hold over 50% of our debt.  it’s not a sure thing they’ll continue to buy our treasuries.  They might decide to invest in stocks, commodities, or real estate.
  2. Borrow from US citizens.  Americans will have to increase their savings rate and buy more US Treasuries.
  3. Print money. “With government expenditures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap. Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes.”

I agree with Warren’s conclusion:

“Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.”

For further reading:


BOOK REVIEW: Technical Analysis Using Multiple Timeframes

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Inflation: To Be or Not To Be – Part 5 of 5

Lastly, when inflation does return:

5. How high will inflation go?

Given the high level of slack likely to remain in the economy during the next two years, there could actually be some deflationary pressures that linger in the system. For example, unemployment isn’t expected to peak until 2010 at over 10%. Industrial capacity utilization rates are at their lowest levels ever, which means a lot of unused capacity in the manufacturing sector. This slack must be cinched up before upward pressure is put on wages and other prices. Double-digit inflation outbursts remain unlikely in the short to medium term.

However, in economies where there is less slack, i.e. China and India, prices could rise more quickly. Commodity prices have been driven more from emerging economies than wage growth in the U.S. In mid 2008, CPI hit 5.4% driven mainly by commodity price spikes despite the fact the U.S. economy had been in a recession for 6 months at that point.

BOTTOMLINE ANSWER: If the Fed is not quick enough to withdraw liquidity as money velocity picks up, prices are likely to rise. Rampant inflation may not occur if the U.S. remains below its potential growth rate.


Continue reading:

Source: MARE group

Inflation: To Be or Not To Be – Part 4 of 5

We’ve looked into the reasons why inflation hasn’t occurred yet. This time, I’d like to answer the obvious next question:

4. When will inflation return?

Inflation is likely to pick up when the velocity of money stabilizes and banks start to lend again. Presumably, this will occur as the economy gains traction.

Whether or not the pick-up in money velocity leads to higher inflation depends on how quickly the Fed pulls the reins back on the extraordinary credit it is currently providing. In theory, the Fed can take actions to reduce the size of its balance sheet, in practice, this will be a challenge.

The Fed has the power to end the extraordinary lending programs in put in place during the crisis, mop up the excess reserves of money in the banking system (by raising the Fed funds rate), and sell off the long-term securities (mortgages and Treasuries) it has purchased. Timing will be extremely tricky however. Time it wrong, and we could go back into a double-dip recession. Given the sheer size of the balance sheet reductions that need to be made, perfect timing may be nearly impossible.

BOTTOMLINE ANSWER: Inflation will return when velocity of money stabilizes and banks start lending freely again.


Continue reading:

Source: MARE group

Inflation: To Be or Not To Be – Part 3 of 5

In Part 2 of this series, we looked at the reasons why higher inflation is expected. Today, we take a look at the reasons why, in spite of all the necessary ingredients to inflation being in place:

3. Why hasn’t inflation occurred yet?

Although a lot of money has technically been created, much of it isn’t being used. “Velocity”, a common term in an economist’s vocabulary, refers to describe how quickly money changes hands as it is lent time and again throughout the financial system food chain (lent, spent, deposited, lent out again). Inflation is not only a function of the amount of money, but also its use, and a lack of velocity can offset an increase in money supply.

For now, much of the increase in bank reserves is sitting idle on deposit with the Fed, meaning banks are remaining cautious about making new loans. Restoring their balance sheets to health remains a higher priority than new lending.

Meanwhile, additional downward pressure on prices are being caused by growing slack in the economy and continued deleveraging by consumers. Unemployment rates are at 26 year highs and consumers are saving more and spending less. With these factors in place for at least the foreseeable future, there is little upward pressure on prices for consumer goods.

BOTTOMLINE ANSWER: Inflation hasn’t occurred yet due to lack of velocity of money and consumer spending slacking off due to unemployment.


Continue reading:

Source: MARE group

Inflation: To Be or Not To Be – Part 2 of 5

Last time, we looked at the first of 5 key questions in regards to the threat of inflation: Is inflation accelerating?

The second question that needs answered is, with all the fuss in the media:

2. Why is higher inflation expected?

The godfather of modern monetarist economic thought, Milton Friedman, defined inflation as “too much money chasing too few goods and services.” As a result, the textbook prescription for inflation is an excessive increase in the amount or use of money relative to economic output.

Today, the governments response to the financial and economic crisis in late 2008 has put the printing presses into overdrive. Chief among the astronomical growth in the monetary base is the fact that the Federal Reserve has tried their hardest to prevent the collapse of the U.S. financial system. To do this, they flooded the economy with newly minted cash…and the monetary base is now tuning in at $1.7 trillion.

Compounding the problem is the massive borrowing by the U.S. government to finance its large and growing budget deficit. Historically, huge borrowing needs have lead to the temptation to inflate away the deficit, by excessively growing the money supply to make servicing the debt easier through the creation of cheaper money. While inflating the debt away is probably not the Fed’s ultimate objective, history has shown that massive government debt places tremendous political pressure on central banks to attempt to inflate their governments back to fiscal health.

BOTTOMLINE ANSWER: There are 2 main reasons of why higher inflation is expected. First, the Fed is growing the money supply and that can at some future point create ‘too much money chasing too few goods and services’, the exact prescription for inflation. Also, the governments massive borrowing to finance huge budget deficits is compounding the problem.


Continue reading:

Source: MARE group

Inflation: To Be or Not To Be – Part 1 of 5

Turn on any financial newscast or open any newspaper and you’ll surely find a debate on the threat of inflation. Inflation is of particular importance to investors because it erodes purchasing power and historically has affected the returns of stocks and bonds.

In this blog series, I will provide answers to 5 key questions that are pervading everyone’s mind.

1. Is Inflation Accelerating?

Despite the headlines, actual inflation has remained muted. The U.S. Consumer Price Index (CPI) actually declined 1.2% YOY, representing the biggest drop in prices since 1950.

However, there is usually a lag before inflationary pressures tend to show up after the deluge of government bailouts and trillion dollar deficits. CPI generally offers little information about where inflation may be heading. Looking at a group of more forward-looking, market based inflation indicators can sometimes clarify. Here are a few:

  • Commodities – such as gold and crude oil, have staged a broad-based rally from their lows in 2008.
  • Long-term Treasury Bond Yields – nearly doubled in 2009.
  • Implied inflation rate in TIPS – climbing, showing a big increase from the 5 year deflation predicted in 2008.

However, at these levels, the indicators do not appear to provide any support for spiking inflation rates (i.e. hyper-inflation). Crude oil is still 50% lower than it was last year, Treasury yields are near their lowest ever, and TIPS prices project only 1.4% inflation over the next 5 years.

BOTTOMLINE ANSWER: Yes, there are signs that inflation is accelerating, but not at an unusually high rate.


Continue reading:

Source: MARE group