Whenever I am way off the mark I take a step back, watch and think. It is hard for me to be this way off the mark with respect to the Fed. I was wrong, and I mean WAY wrong on Bernanke’s and the Fed’s decision on how their decision (1,2,3).
When I am this way off I figure that I must have missed something. I must have not considered a certain factor. Thus I need to see how things play out. And what I privately feared with the 50 basis cut is coming true. I thought that they would not cut 50 basis points due to the ramifications of a weak dollar.
Here are the currency exchanges rates at 7:28 September 20, 2007. (Order: USD:YEN, EUR:USD, USD:CHF, USD:CAD)
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And here are the exchange rates on Friday September 30, 2007.
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I feared an interest rate cut would weaken the dollar. Of course idiots like Kudlow say the opposite.
I also suspect that over time, the improved economic growth outlook for the U.S. will actually strengthen the dollar’s exchange rate, in part because the interest tax on money has been lowered.
Kudlow is right in that when an economy is strong the currency becomes strong. But what Kudlow and co missed is the problem of addressing the underlying problems that will not be addressed by a lower interest rate and lower dollar. It’s like me saying what burglar system do I need if I am rich? The problem of burglar system involves overcoming a bigger problem of getting rich in the first place. Until you are rich any talk regarding the burglar system is pointless.
There are two problems as I see them: Real Estate Bubble, and Inflation.
Let’s start with the real estate. Bubble tracking hit the nail on the head with the following comment.
Well, I would like to propose that we as a nation start looking at Housing over the last 3-5 years as having experienced a ‘false spike’. In essence, the price increases were not real, they were made up! How so? With all of the fancy financing, the numerous zero down speculations, the over-appraisals, the cash-back at closings, and the overwhelming number of outright fraud, the market place was basically built on false comps and sales based on those false comps. And as such, the price freefall seen in the various bubble markets are really just a return to the norm, a chance to wipe away the false comps fast and easy.
In this week’s Business week there was an interesting “If these walls could talk.”
- July 1994: Couple bought house for 230,000
- March 2003: Refinanced for 313,000
- July 2005: Sold to flipper for 815,000
- March 2006: Sold again for 1.29 million
- August 2007: Listed for 900,000
See the problem? Yet as Bubble tracking point out, and as I see it Bernanke and the Fed don’t get it. The house is not worth 900,000, and the house needs to drop by 50% after increasing by 100% to become normal. Cutting the interest rate will only help those flipped, refinanced their homes, etc. The housing bubble made people slap on debt without thinking twice. Think hard about this. People took out equity on their home so that they could spend it, even though they would have to pay back that money. That type of behavior is financially wrong.
The basis cut is supposed to help grease the economic wheels, but I wonder if a house that is overpriced should be greased? Many say, oh look at those poor sub-prime people. Well, sub-prime is a problem, but I am tempted to guess the bigger problem is not sub-prime, but those that leveraged using lower level interest rates.
The second problem I see is inflation. As Long and Short Capital pointed out.
Dear the Fed,
You suck. You don’t have a backbone and as a result you are slowly and very surely making our country and our currency irrelevant. Usually the masses rebel and bring down great empires but luckily for us democracy fixed that problem. Unfortunately, democracy can’t fix how lame and fickle you are and so you will be our ruin.
Inflation is everywhere, eg Germany, and China. Yet America has slowing inflation? Give me a freaken break! This is BS pure and simple. Rick Santelli has hinted at such, and the following article is more critical.
“If you don’t drive or don’t eat, maybe the CPI (consumer price index) has a little resemblance to your life. But I don’t see how anybody with any ordinary experience could see the CPI is being accurate,” Rutherford said.
Rudolph-Riad Younes, a co-manager of the Julius Baer International Equity Fund, told Barron’s magazine this month that if the government counted home prices and energy correctly, the real inflation rate would be between 7 percent and 10 percent.
John Williams, a Dartmouth-trained economist who works as a consultant for a number of Fortune 500 companies, says the only reason the inflation rate is so low is because the Reagan and Clinton administrations rewrote the way the CPI is calculated.
In his monthly online newsletter Shadow Government Statistics, Williams has painstakingly attempted to recreate the inflation rate using its older guidelines. Under his calculations, inflation is actually running at an annualized rate of 9.95 percent.
Think hard about this. If the real inflation rate were running at 9.95% what would the Fed be doing? Ramping interest rates up hard. Imagine if they had calculated inflation using the old way, then maybe this housing bubble might have been stopped before it got to the point it is getting now. The Fed, and all of the other central banks of the world kept juicing the system and now look at the FREAKEN mess!
Though what many question is why is the CPI calculated the way it is? Is it politics? Here is the line of thinking from the Fed. A Fed is interested in keeping a long term stable economy. Food, which is directly related to the immediate does not fit into long term thinking. So if one year tomatoes are expensive and next year they are cheap you have one inflationary year and then a deflationary year. This is not long term thinking.
Thus if you ignore food and energy what you are ignoring is the short term and focusing on the long term. And if food and energy does stay more expensive then in the long term those prices will be reflected in the end price as inflation in the economy. The line of reasoning is that if food becomes expensive over the long term people will ask for higher wages, causing a company to increase prices, causing CPI inflation to creep up.
Though why low CPI? Should the higher food and energy prices cause a higher CPI? No, because it directly relates to lead paint. Let’s say a company is faced with a worker who wants more money. What do they do? They offshore, they hire illegal workers, and that lets a company stop inflation at the corporate level before it reaches CPI. Though, and here is where things get scary. Inflation does not disappear, inflation persists, and somebody has to be squeezed. The result is that companies cut corners whenever they can, and they build toys with lead paint because they cannot afford to otherwise.
By using these techniques companies and countries have higher productivity and lower CPI even though the underlying problem is festering. My beef with the CPI is not that it is incorrect, but that it is an abstraction of the underlying indicators. Abstracting the problem will not make the problem go away.
So now let’s wrap this up, by cutting 50 basis points and a weakening dollar you are not strengthening the American economy. Kudlow has this completely wrong. American products still need commodities and those are going up. So yes American labor is getting cheaper, but that benefit is disappearing due to the fact commodities are getting expensive. And don’t even dare say that America has a higher productivity. Part of that productivity increase is due to off-shoring and illegal workers. Though off-shore implies non-American dominated currency, and thus off-shoring becomes more expensive.
Think back to when off-shoring became mainstream in circa 1995. The dollar and countries buying the products from off-shore were strong. Thus commodities and off-shoring was cheap and increased productivity by leaps an bounds. This is like leverage, but it cuts both ways. Now it happens to cut the other way.
If America is slowing down the rest of the world will do ok, right? Remember there is “global growth”, which EVERYBODY is talking about. Let’s think about this a bit. China is growing, but China is supporting its growth by selling to the US. Germany and Japan are major exporters that have a local economy that could not even punch itself out of a wet paper bag. So if the American economy slows you take out China, Germany, and Japan. You might as well call this a global recession or depression.
Though I do see one bright spot, and it is Brazil / South America in general. The Hispanics are becoming a real force and their economies are finally taking shape. Though they cannot support an entire world economy.
In the end I am not optimistic about the future.
Lockhart said he was concerned about the housing market given the turmoil in the mortgage financing market and the large inventory of unsold homes.
Hmmm, so why are there so many unsold homes? Does the Central Bankers even want to GET it? Are they in denial? Just like how the Japan is still in denial?