Saturday, May 31, 2014

Ever Wonder How the US Spends it Money?

Ever wonder how are tax/borrowed dollars are spent.  The chart below lays it out pretty simple.

Once again I got this from a really good site that I strongly recommend that you visit.

The following slide can be seen at:

Are We Going to See Higher Inflation Any Time Soon - 
Probably Not - Part 2

Below is the April monthly summary from the American Institute of Economic Research about about inflation.  Once again this is an excellent summary from the AIER about the current state of the economy and inflation.  Basically, we are probably not going to see a rapid increase any time soon.  The basic dynamics to drive higher inflation (higher money supply) are not in place. 

The article is in italics and the bold is my emphasis.  From the AIER:

In the debate over the risks associated with quantitative easing, inflation hawks point to the massive build-up of reserves in the banking system as a potential source of inflationary pressure. Inflation doves counter that despite the massive build-up of reserves over the past few years, inflation has remained below the Fed’s target of two percent a year, a somewhat unexpected result.  

Similarly, economic theory suggests that substantial reserve creation should push the dollar’s value downward versus other currencies. Yet the dollar has strengthened generally over the past few years, another unexpected result. Surprising or not, the stronger dollar is an important factor in keeping a lid on inflation.
Strong Dollar Benefits
As the U.S. dollar strengthens against the currencies of its trading partners, it takes fewer dollars to purchase imported goods, and the prices of imported goods into the U.S. tend to fall. The lower-priced imported goods then tend to put downward pressure on the prices of competing domestically-produced goods. 
Over the past twelve months, the U.S. dollar has risen by about one and a half percent against a broad, inflation-adjusted, trade-weighted basket of foreign currencies. Over that same period, the U.S. import price index has declined about 0.3 percent. Since movements in the dollar tend to lead movements in import prices by about two months, the dollar’s recent rise suggests flat-to-lower import prices in the coming months (Chart 1).
While the broad economy benefits from lower-priced imports in general, the Consumer Price Index (CPI) is most affected by imported consumer goods, both autos and non-auto goods. Like the broader import price index, the import price indexes for autos and non-auto consumer goods are strongly and inversely correlated with the value of the dollar—that is, they are sensitive to dollar movements.  As a result, we know that import prices for autos and non-auto consumer goods, in particular, are likely to be very tame over coming months (Chart 2).
Imports and Consumers
Consumer spending totaled about $11.8 trillion at an annual rate in the first quarter of 2014, accounting for roughly 68 percent of total gross domestic product (GDP) of $17.1 trillion, in nominal terms. Within consumer spending, outlays on goods totaled $3.9 trillion at an annual rate, or approximately one-third of total consumer expenditures. During the same period, imports of autos and non-auto consumer goods totaled $843 billion at an annual rate, the equivalent of around 22 percent of total consumer spending on goods (Chart 3).
Competition and Productivity
The net effect of a strengthening dollar and lower-cost imports of consumer goods is downward pressure on core consumer goods prices. Domestic manufacturers are pushed to respond to the lower-cost imports by restraining their own costs of production in order to remain competitive.  Slow wage gains over the past several years have helped domestic manufacturers remain competitive, but as labor markets tighten, that influence may wane. 
On a positive note, while labor costs may begin to see upward pressure, productivity gains could also accelerate, keeping unit labor costs in check. Over the past two years, productivity gains have slowed to around 2.2 percent, a percentage point below the longer-term trend growth of about 3.3 percent (Chart 4). As output growth slowly accelerates—and as competition intensifies, technological innovation continues, and capital spending rises—it’s likely that productivity growth will move higher. Higher productivity growth will help to restrain costs and keep price increases moderate.
Sharp Divergence
Lower-cost imports and relative productivity gains are two key reasons for a sharp divergence in the price behavior of core consumer goods and core consumer services. Over the last twenty years, the two major components of core consumer prices show very different patterns. While both categories have seen decelerating price increases, called “disinflation,” the pattern has been much more pronounced in core goods prices. In fact, core goods prices have experienced periods of outright price decreases, or “deflation.” Core goods price inflation currently is trending about flat, while core services price inflation remains above the Fed’s two percent target for overall inflation (Chart 5).
Monthly Inflation Measures
The CPI rose 0.3 percent in April, the largest monthly increase since June 2013. Over the past twelve months, the total CPI has risen 2.0 percent, in line with the Fed’s long-run target. Food and energy were among the main contributors to the April gain, rising 0.4 percent and 0.3 percent, respectively. Over the 12-month period through April, food prices have gone up 1.9 percent while energy prices have jumped 3.3 percent. The year-over-year rise in energy prices over the past year is largely due to a 77 percent annualized increase in gas utility prices over the January-to-March 2014 period.
The CPI excluding food and energy rose 0.2 percent in April and has increased 1.8 percent over the past year (Chart 6). As already discussed, the primary sources of inflationary pressure have come from core consumer services. The largest contributors to core services price increases in April were: housing, up 0.2 percent in April and 2.8 percent over the past year; hospital services, up 0.5 percent in April and 6.1 percent over the past twelve months; motor vehicle insurance, up 0.9 percent in April and 4.4 percent year over year; and college tuition, up 0.4% in April and 4.0 percent for the year.
Among core goods, weak pricing power was evident in: household furnishings, down 0.3 percent for the month and down 2.3 percent for the year; apparel, flat for April and up just 0.6 percent for the year; transportation-related goods, up 0.3 percent for the month but up just 0.1 percent for the last twelve months; recreational goods, unchanged in April and down 2.3 percent over the past year; and information technology goods, down 0.1 percent in April and down 5.9 percent for the year.
Demand and Supply
Demand for consumer goods continues to be supported by ongoing modest gains in jobs, wages, and total personal income. Average hourly earnings have risen 1.9 percent over the past year; when combined with an increase in payrolls and lengthening average workweek, the wages and salaries portion of personal income has been rising at a 3.7 percent annual rate.
Consumer credit growth has rebounded from the period of sharp contraction that began in early 2009. Overall consumer credit has been growing at greater than a five percent rate, on a year over year basis, since August 2012, a run of 20 consecutive months. However, nearly all the gains have come from non-revolving credit, particularly auto and education loans. Revolving consumer credit, primarily credit cards, has been growing at a very meager 0.8 percent annualized rate over the past two and a quarter years (Chart 7).
The income and credit gains have translated into rising retail sales in general and rising auto sales in particular. Retail sales have gained 4.0 percent over the past twelve months, while unit auto sales have held above the 15 million-annual-rate mark for 18 consecutive months.
On the supply side, industrial production is up 3.4 percent for the twelve months through April, though the gain for manufacturing is a milder 2.9 percent. Consumer goods manufacturing has gained a modest 2.4 percent over the past year.
Total business inventories have increased 4.7 percent over the past year, while retailers have grown stocks by 6.1 percent. When compared to current selling rates, the total business inventory-to-sales ratio came in at 1.30 months—equal to the average of the prior three months, though up from a low of 1.25 months hit in April 2011. Retailers’ inventory-to-sales ratio has moved up to 1.42 months in March from a low of 1.34 months in February 2012, though the March reading was down from 1.45 months in January. In general, a falling inventory-to-sales ratio suggests tighter supplies of goods.
Final Word
Consumer prices overall are firming in response to improving economic fundamentals. However, the strong dollar promotes lower-priced imported consumer goods, which in turn foster competition that helps to restrain goods price increases. But offsetting inflationary pressures continue, emanating from food, energy, and certain areas of core services.
Looking ahead, the build-up of reserves in the banking system presents the risk of upward inflation pressure. But other factors—including soft credit demand, restrictive lending practices, and the slow-growth economic environment—seem unlikely to support a sustained inflation surge over either the short- or intermediate-term time horizons.
Taken together, these countervailing forces suggest continued modest inflation ahead.

Tuesday, May 27, 2014

Who Holds the US Debt?

Below is a chart showing who holds the US National Debt.  The numbers are from the end of the year, but things have not changed that much in the last five months.  About 2/3s of our debt is owed to ourselves if you throw in the Fed.  In terms of foreign countries China holds the most at about 7.75% of our National Debt followed by Japan at about 7.1%.  The Social Security Administration holds about 16.5% of our debt.  

I found this chart at a really interesting website called  I strongly recommend that you visit this site for some interesting perspectives on our current economic and financial situation.  In addition to the individual slides the author has some fairly well written presentations.


The Debate Between Austerity and QE - Europe a Real Life Example

In my mind the debate concerning the fiscal policy of austerity and the expansionist monetary policy of QE is not worth having, because austerity is not a viable option.  But, don't believe me, just look at Europe.

Article is in italics and the bold is my emphasis.  From the UK Telegraph:
Sweden has become the first country in northern Europe to slide into serious deflation, prompting a blistering attack on the Riksbank’s monetary policies by the world’s leading deflation expert.
Swedish consumer prices fell 0.4pc in March from a year earlier, catching the authorities by surprise and leading to calls for immediate action to avert a Japanese-style trap.
Lars Svensson, the Riksbank’s former deputy governor, said the slide into deflation had been caused by a “very dramatic tightening of monetary policy” over the past four years. He called for rates to be slashed from 0.75pc to -0.25pc to drive down the krona, and advised the bank to prepare for quantitative easing on a “large scale”.
Prof Svensson said Sweden was at risk of a “liquidity trap” akin to the 1930s, with deflation causing debt burdens to ratchet up in real terms. Swedish household debt is 170pc of disposable income, among Europe’s highest.
The former Princeton University professor wrote the world’s most widely cited works on deflation, his advice being sought by the US Federal Reserve’s Ben Bernanke during the financial crisis.
The dispute in Sweden comes as Eurostat data showed that eight EU countries slipped into deflation in March, with Bulgaria at -2pc, Greece -1.5pc, Cyprus -0.9pc, Portugal -0.4pc, Spain and Slovakia -0.2pc, and Croatia -0.1pc.
The Netherlands is still positive at 0.1pc, but this level is already so low that it is causing debt-deflation trauma for Dutch households struggling to cope with loans near 250pc of disposable income. Dutch house prices have dropped by a fifth. A quarter of mortgages are in negative equity.
Quantitative easing by the Bank of England has allowed Britain to avoid negative equity on a large scale. UK house prices have fallen in real terms, but the real debt burden has fallen with it.
Britain’s inflation is now the highest in the EU at 1.6pc but still below target. The UK is one of the few countries left in Europe with an ample safety buffer against an external shock.
EMU-wide inflation fell to 0.5pc in March, far below the European Central Bank’s (ECB’s) 2pc target. Andrew Roberts, from RBS, said the rate was nearer 0.3pc after stripping out VAT tax rises. The RBS “deflation vulnerability indicator” has risen to 80pc for Spain, 64pc for Ireland, 55pc for the Netherlands and 52pc for Portugal.
Peter Schaffrik, from RBC, said eurozone inflation was likely to rebound in April since the timing of Easter distorted the data, but warned that there was a “powerful dynamic” holding Europe back. He said the European Central Bank would have to ask whether its staff model was reliable.
Sweden’s Riksbank admitted in its latest monetary report that something unexpected had gone wrong, perhaps due to a worldwide deflationary impulse. “Low inflation has not been fully explained by normal correlations between developments in companies’ prices and costs for some time now. Companies have found it difficult to pass on their cost increases to consumers. This could, in turn, be because demand has been weaker than normal,” it said.
The Riksbank has been trying to “lean against the wind” to curb house price rises and consumer credit, pioneering a new policy that gives weight to the dangers of asset bubbles. But this is proving easier said than done without hurting the productive economy, suggesting that it may be better to use mortgage curbs or other means to rein in property mania.
It is unusual for the Riksbank – the world’s oldest central bank – to be accused of being too hawkish. Swedish economists have been among the most avant-garde for a century. John Maynard Keynes borrowed many of his boldest ideas from the Stockholm School in the 1920s. Sweden largely avoided the Great Depression because the Riksbank tore up the rule book and pursued a reflation strategy very early, with great success.
The dispute over deflation in the eurozone has become increasingly acrid. J├╝rgen Stark, the ECB’s former chief economist, accused the International Monetary Fund and others calling for QE of scaremongering. “Warnings about outright deflation and calls for ECB action are misguided and irresponsible,” he wrote.
The IMF says there is a 20pc risk of deflation in the eurozone. It also warns that chronic “lowflation” of 0.5pc is also corrosive, making it harder for Italy, Portugal and others to claw back competitiveness without suffering a further rise in their debt ratios. Each year of lowflation pushes southern Europe closer to the limits of debt sustainability.

Are We Going to See Higher Inflation Any Time Soon - Probably Not

Below is the March summary from the American Institute of Economic Research about the possibility of inflation increases any time soon.  Once again this is an excellent summary from the AIER about the current state of the economy and inflation.  Basically, we are probably not going to see rapid increase in inflation any time soon.  The basic dynamics to drive higher inflation (higher money supply) are not in place.  I would just like to add that of the two types of economic policy that can be practiced by a government/central bank, namely fiscal and monetary, the monetary policy practiced by the Fed tends to move slower.  In other words its policies take longer to work their way through the economy.

The article is in italics and the bold is my emphasis.  From the AIER:

The Federal Reserve’s quantitative easing policy ignited inflationary fears, but inflation as measured by the Consumer Price Index has remained low for several years. The QE program began in late 2008 as an attempt to stimulate the economy out of recession. Three rounds of quantitative easing have totaled $3.5 trillion.

QE’s goal was to keep short-term interest rates low to stimulate investment demand and reduce unemployment. At the same time, QE was intended to help banks rebuild balance sheets after the financial crisis. Many believe these outcomes have been achieved.

But quantitative easing has encouraged a clear trend in bank and Fed balance sheets. A substantial amount of excess reserves have been accumulating for the last several years. Large banks such as Wells Fargo, JP Morgan Chase, Goldman Sachs, and Bank of America maintain hundreds of billions of dollars at the Fed. In March 2014, reserves totaled $2.7 trillion and accounted for about 19 percent of commercial bank asset-side balance sheets, compared to less than 3 percent before the crisis.
QE has driven the monetary base, the sum of currency in circulation and reserve balances, to nearly $4 trillion. This is more than 400 percent higher than in mid-2008. However, the M2 money supply, the sum of cash, checking accounts, savings accounts, and money market funds, has not increased at nearly the same rate. M2 totals $11.16 trillion, an increase of only 40 percent since mid-2008 (see Chart 1). A measure known as the money multiplier assesses the spurious relationship between the monetary base and the money supply.
Fed policy can effectively increase the monetary base, but does not necessarily increase money supply at the same rate. Banks, not the Fed, are the fundamental actors that affect money creation in an economy. Inflationary fears are fueled by the risk that these massive quantities of reserves could flow from bank balance sheets into the economy creating an uncontrolled jump in the money supply.
If the historic relationship between the monetary base and monetary supply held, the immense increase in the monetary base should have caused a parallel jump in money supply. This didn’t happen. The multiplier has dropped sharply, largely because banks have not loaned out the money, but have held it in reserves.
As the economy improves, the question is whether lending will accelerate beyond the ability of the Fed to control inflation. Fed Chairman Paul Volcker was able to use money supply targeting to curtail inflation in late 1970s. The prime lending rate climbed to over 21 percent at the time, and two recessions followed shortly thereafter. This strategy is now filed under “in case of emergency.”
Today, the Fed is developing new strategies to neutralize excess reserves. These new strategies focus on incentivizing banks to maintain balances at the Fed in lieu of lending. The new methods are theoretically sound, but untested in reality.
Economic Recovery
The recent recession was unprecedented. From peak to trough, the recession saw a 6.3 percent drop in total employment and a 5.5 percent decrease in GDP per capita. The GDP downturn was the worst of the last 12 recessions. The decrease in employment was rivaled only by the post-WWII downturn. QE supporters argue that the depth and severity of the downturn warranted extraordinary measures.
Chart 2 shows total employment deviation from peak to trough and back again for the last 12 U.S. recessions. The employment nadir is oriented at time 0 on the horizontal axis. The pattern of historical recessions shows that the length of time from peak to trough is similar to the length of time for employment to return to pre-recession levels. Other metrics that characterize recessions, such as GDP, show the same pattern.
Those that question Fed policy point to the long, slow recovery as evidence of its mismanagement. The recovery took significantly longer to regain its pre-recession levels. But it is unknown how long the recovery would have taken without Fed intervention. The U.S. recovery has been slow, but has been superior to that of Europe, the UK, and Canada. The argument over the central bank’s role and involvement in the economy will continue.
The demand for goods, services, and business investment drives the demand for money. The relationship between banks and borrowers—the supply and demand for money—drives inflation. The Fed incentivizes banks with its various tools to influence the supply of money. The debate is about the strength and effectiveness of the Fed’s influence.
Retail and Wholesale
Broad CPI inflation maintained its slow growth in March. CPI services prices have outpaced durable goods and the broader CPI. Over the last 10 years, medical care services prices jumped 46 percent, college tuition and fees have soared 74 percent, and the broader CPI has increased only 26 percent. In fact, durables prices have decreased by 4 percent over this time frame.
This contrast has critical implications for the American economy. The elderly and others with health issues shoulder a larger share of medical costs through increased out-of-pocket expenses. Recent graduates are increasingly entering the workforce with a sizeable debt load from student loans.
On the other hand, middle-aged households with substantial mortgages may benefit from broader inflation. Yet these people have not been exposed to significant inflation like recent graduates and the elderly. The youngest and the oldest seem to be shouldering inflationary pressures.
Import prices have accelerated over the last three months, indicating rising global prices. Crude oil prices have jumped over 5 percent since January. Oil prices impact production and transportation costs. If import prices continue to rise, domestic companies may find wiggle room to likewise increase prices while remaining competitive.
March saw accelerated inflation at the wholesale level. The Producer Price Index (PPI) increased 0.5 percent for February and was up 1.5 percent on a year-over-year basis. The PPI indicates inflation at a more rudimentary level than the CPI and can often provide a short-term warning for increased consumer inflation.
Demand and Supply
As discussed earlier, increased money supply can result in inflation. Average earnings growth remains weak, and employment is slowly increasing. Banks can create money in the economy by lending for cars, houses, college tuition, and business investment. The U.S. economy will only see significant inflation when lending and borrowing surges.
Interest rates are expected to rise as inflation accelerates and the Federal Reserve reacts. Will consumers rush to purchase homes and cars ahead of increasing interest rates? March recorded the strongest monthly auto sales since 2012. Non-revolving credit, which includes auto and student loans, experienced robust gains as well. Contrary to these gains, existing and new home sales fell.
Retail sales figures were strong in March and have risen 3.7 percent on a year-over-year basis. It is now clear that retail sales weakness in December and January was largely a result of uncooperative weather.
Manufacturing and production showed continued strength in March. The industrial production index (IPI) posted an increase of 0.7 percent. The IPI again stands at its all-time highest measure. Increased IPI measures were coupled with increased capacity utilization, which increased to 79.2 percent, the highest level since mid-2008. If production continues to grow and capacity becomes constrained, there could be added demand for business borrowing.
The Senior Loan Officer Survey is a quarterly survey that observes bank lending practices. The most recent results, from January, indicate that banks have eased lending policies for commercial and industrial loans and experienced increased demand for such loans. Increased competition for loans was a primary reason cited for the eased standards. The survey also indicated a modest decrease in demand for mortgages. Although lending standards have somewhat eased across the board, the demand for most loans has only moderately changed.
In general, the supply of available money for lending is ample. Constrained demand for loanable funds has kept inflation low.
Final Word
Thirty years from today, we’ll look back and debate whether Federal Reserve intervention after the Great Recession had the desired impact. One thing is certain: The magnitude of the recession was unlike other recent downturns. A debate rages on about whether the Fed is the cause of economic volatility or the answer to it.

Saturday, May 3, 2014

Investing and the Rule of 20

This was recently brought to my attention by a friend and I thought it was an interesting and easy way to think about stock market valuations.  Basically the P/E ratio for the S&P 500 plus the inflation rate gives you a sum that is greater or less than 20.  Above 20 means the stocks are overvalued.  Under 20 and stocks are undervalued.  As of the end of April 2014 this index was 18.5.  

Be sure to use this context.  This is not a short term measure.  It is more of a longer term metric that can be checked every month or quarter.

Below is chart from Bloomberg/Business Week explaining the concept.

Below is a more academic article that basically supports the Rule of 20.  Is it perfect all the time - no.  Does it work a lot of the time - yes.  This could be useful at times when the market seems overvalued.  The article can be found in the Journal of Financial and Strategic Decisions - Fall 1999.  By the way, if you get a chance, looking around on the site can be informative.

These comments are not an endorsement of the Rule of 20.  Please do your own research on this metric.