Tuesday, November 08, 2005

Who is the 'US consumer'?

A lot of talk these days focuses around valiant US consumers (USC's).

These non-mythical creatures are supposedly helping to fuel world economic growth.

But who are they? What are they?

They're wealthy.


You might think you've seen a USC walking around the streets of America.

But a lot of these people look quite poor; surely they aren't the USC's you read about...

They aren't.

They're poor.

The USC's you've heard about are probably doing their shopping from home, on the internet.

Sharing the American pie

The fact is over two-thirds of the US population is doing quite nicely.

They probably have a good job and live in a nice home.

In the past these USC's have caved in to the pressures of standing to lose both.

These days they only have to worry about one of those problems, if at all.


Unusually low real interest rates in the US over the past few years (see next piece) have put USC's minds at rest.

They can sleep easily in their beds and shop happily on their computers.

The Federal Reserve has been studying these USC's for a while now and knows exactly what they need to do in order to save them from extinction.

Spending begins at home

The chart above shows US home prices over the past 50 years. The shaded ares are recessions.

For the first time over that period home prices have continued to grow while the economy shrank.


Negative real interest rates.

People have been able to borrow money at such a low rate of interest that makes it look like a sure bet.

While there's no free lunch, the bill doesn't necessarily have to come at the end of the meal.

The cost of buying a home isn't fully realized until it's finally paid off.

This depends on what happens to interest rates.

At the moment interest rates are still low and look likely to remain so.


Gradually rising interest rates won't hurt USC's.

Rapidly rising rates will.

The Fed knows this.

It will do everything in it's power to prevent it from shooting itself and USC's in the foot.


Tuesday, October 11, 2005

Follow the money: part 2

15 months ago, I explained why the Japanese economy wasn't worth getting excited about.

For the same reasons, it still isn't.

However, given Japan's recent upturn, it may be tempting to at least start getting excited.

This week, The Economist succumbed to just that temptation.

Just like the magazine, I didn't buy it.

Did you?

One key piece of economic data that I look to for any sign of confidence in an economy is its money supply (the first column on the left shows the growth rate tending lower in 2005).

This represents the blood flowing through the veins.

If it doesn't circulate well, there's something wrong.

Judging by Japan's money supply, there's still something wrong with their economy.


It's only when Japanese individuals and companies are ready to use money, intead of putting it away for a rainy day, that brighter days will come.

Unfortunately, this is a self-fulfilling prophecy: the less confidence Japanese have in their economy, the worse it will continue to perform.


The recent strategy of Japan's central bank has been much like its over-prescribing doctors: pumping the patient (economy) with excessive amounts of drugs (liquidity).

While Japan has been drugged up with money, China has raced ahead and now poses a greater threat than ever.

Japanese firms are right to be cautious about investing their money. Only when that money gets put to use will Japan be ready to take on China, Korea and the rest of the world.

Until then, the light at the end of the tunnel will remain the headlights of China and others heading straight for it.

Wednesday, September 21, 2005

Why economists shouldn't forecast

Hindsight provides an opportunity to learn from our mistakes.

Ideally, we learn enough about our mistakes never to repeat them again.

Economists who make forecasts disagree: The past is in the past. The future is different and uncertain. It's hard to disagree with that. After all, economists know what they're doing, right?

Not quite.


Over a year ago I wrote about the assumptions economists need to make. The International Monetary Fund has just published its World Economic Outlook, with it's regular section on assumptions (pdf, p.viii).

In 2004, the IMF made the following assumptions about oil prices:

"... the average price of oil will be $30.00 a barrel in 2004 and $27.00 a barrel in 2005, and remain unchanged in real terms over the medium term." (viii)

These levels were clearly way off course, as were their forecasts for economic growth.

In 2005, they now assume the following for crude oil prices:

"... the average price of oil will be $54.23 a barrel in 2005 and $61.75 a barrel in 2006 (viii)

Naturally, these forecasts are wrong as are their forecasts for economic growth.


The moral of this story?

(1) Always consider the assumptions behind an economist's forecast;
(2) Never trust an economist's forecast;
(3) Economists shouldn't make forecasts.


(4) Your forecast is as good as an economist's!

Sunday, September 18, 2005

A real dilemma

If you're one of those people who expects the U.S. Federal Reserve to stop raising interest rates next week then you probably don't look at enough charts.

If you were to look at the charts the Fed looks at then you would understand why to stop raising interest rates now would defeat the purpose of the past 12 months of rate hikes.

One piece of data the Fed takes very seriously is the real interest rate; the interest earned on overnight deposits after taking account of inflation (i.e. higher inflation means lower real interest).

Going up

What the chart shows is that real interest rates are currently zero. Putting $1 in your bank account today will earn no interest in real terms. Your dollar today buys you less tomorrow. That's not going to help anyone, including those who survived the hurricane.

What the Fed is aiming towards is a neutral real interest rate. Judging from the past that means we should expect at least another 2% of interest rate hikes by the Fed (measured, not stirred).


Nothing can stand in the way of the Fed on a mission, not even a hurricane. When the time is right, interest rates will stop going higher. If history is anything to go by, that usually means they're ready to head in the opposite direction.

Sunday, August 07, 2005

Conundrum is Greenspan's legacy

Ben Bernanke sure has his work cut out for him.

Once he replaces Alan Greenspan next year, it's uphill all the way. Or should I say downhill...

Until now the U.S. Federal Reserve has been raising interest rates in an attempt to regain 'neutral' ground.

Near-zero interest rates were a recipe for disaster (i.e. Japan) so there was only one way interest could go.

Unfortunately, they haven't gone there quick enough.


Under Alan Greenspan's tentative guidance, the Fed looks like a driver lost in the dark. It knows it has somewhere to go, but it doesn't know exactly how to get there. So it takes it one small step at a time.

One problem with this is the ferrari behind (the bond market) is in a hurry to get where it wants to go!

The Fed is supposed to act as the "guiding light" for the bond market, dictating the future trend of interest rates.

Lately, the Fed has been a poor guide; the ferrari is ready to go it alone.


It's important not to forget how far the Fed has come.

As U.S. politicians continuously remind the public, interest rates are still at a 40-year low. And they got there pretty fast.

The black line indicates the Federal Reserve's overnight interest rate. The red bars are the interest rates on 10-year Treasuries. The Fed sure seemed to know where it was going 2 years ago!

When the Fed set out in a new direction at the end of 2004, the reasons weren't clearly laid out. The only clear fact was that interest rates were too low. The light, it assured the market, was at the end of the tunnel.

The ferrari didn't buy it.

Over the past year the Fed has lost credibility with the public and with the market (something that can only be earned through transparency , a point I made before the Fed started raising interest rates).

The market continues to buy bonds and the public continues to borrow money and purchase homes. The Fed should take a lot of credit for this (no pun intended).


When Alan Greenspan labelled the continuted fall in bond market yields this year a conundrum, it was like a driver scambling to find his current place on the map.

Unfortunately, it's too late for him to do anything about it, other than just vent.

With Bernanke at the wheel, the Fed may regain some credibility with the market and perhaps start leading the way.

Thursday, July 07, 2005

Do you feel safe yet?

It takes a human tragedy to make people realize just how vulnerable they are.

It takes a human tragedy for elected officials to reveal to the public this vulnerability.

New York Mayor, Mike Bloomberg, explained this morning how security measures have been "stepped up" in the subways, on the railways and at the ports in response to the bombings in London.

It doesn't seem the safest way to proceed if, in reaction to an attack that had no warning, that temporary measures are taken, aimed at improving national security. Surely we should have been at this state of preparedness all along?

This raises the question of just how prepared are we for another terrorist attack.

The answer is, it depends on what our elected officials are doing about it!

Today's tragedy helped to reveal just how vulnerable we are, thanks to the insufficient measures being taken by the people we elected for exactly that purpose!

** Afterthought **

I'm not the only one who lacks faith in the government's ability to prevent another terrorist attack. It's the stock market too. The U.S. stock market, and hence the global stock market, has learnt to live with the fact that another attack is coming and it won't be prevented, just reacted to.

Thursday, April 21, 2005

Alan Greenspan raised interest rates today. Did you notice?

Talk is cheap, right?

Not when the chairman of the Federal Reserve is talking.

If he's concerned then financial markets are concerned.

If markets are concerned, then you pay the price.

What did I say?

This morning, Alan Greenspan told congress:

"The federal budget is on an unsustainable path, in which large deficits result in rising interest rates."

So, "unless major deficit-reducing actions are taken" interest rates are more likely to go up than down.

Investors got nervous, thinking this might actually signal higher interest rates (since the person talking sets the target for the overnight interest rate). They sold bonds, pushing yields higher.

As I have discussed before the bond market is what essentially sets mortgage rates. If bond yields go up then your mortgage bill goes higher too.


It's important to remember that for policymakers, words are just as important as actions. Anything they say can be taken to imply something they may do.

Markets are always thinking about the future.

If you think like the market thinks, you can avoid getting hurt by it every single day.

Saturday, April 09, 2005

It's the stupid Economy!

It's very easy to criticize other people.

It's extremely easy to criticize economists.

These dismal scientists are given the thankless task by government to solve problems for which there are a number of different solutions, each with different costs associated with them.

Every solution will come with a cost.

No pain, no gain.


Some economists including, Friedrich August von Hayek , believe that government is the problem.

This is a very convincing argument given the history of evidence stacked against government policies over the recent past.

It seems as if every time the government tries to fix a problem they create another, larger problem in the process.


Of course, different views on any subject represent different parts of the political spectrum, so none will provide the kind of balanced judgement that might convince everyone.

In the current political system, it is only the majority of the voting public that needs to be convinced (every 4 years) in order to choose between (usually 2) competing (and often extreme) alternatives.

Tuesday, March 22, 2005

The dollar's drop cometh

Every day we move a step closer to a dramatic fall in the value of the U.S. dollar.

The pull of gravity is getting stronger by the day.

Until now this pull has been mitigated by a number of forces working in the opposite direction. Unfortunately they cannot hold out for much longer.

There are three major forces waiting to take hold (in increasing order of likelihood):

1. The effects of U.S. statements in favor of a weaker dollar.
2. Reduced dollar holdings by U.S. and international investors.
3. A continually growing U.S. trade deficit.


A record trade deficit is a symptom of a problem that has no solution.

You won't hear the U.S. government say:

"To cut the trade deficit, we are going to..."

A weaker dollar is supposed to help reduce the U.S. trade deficit by making exports cheaper.

Unfortunately, this doesn't get to the cause of the problem: the U.S. imports more than it exports.

It's understandable why the U.S. imports so much.

I often think to myself, as I wonder through a one-dollar-shop, how this is what it felt like 50 years ago. I can buy clothes and groceries using dollar bills and still have change left for the bus ride home (which now costs 3 dollars...).

Of course every country in the world is under the spell of cheap Chinese imports.

However, only the U.S. represents 250 million consumers that use greenbacks to purchase all these goodies.


One thing you do hear the U.S. government say is:

"China needs to revalue it's currency."

A stronger Chinese currency would of course make Chinese imports more expensive. However, the U.S won't say that this will help reduce the trade deficit.

A deficit is not caused or solved by the value of a currency.

If anything it's the other way around: a weaker currency is the result of a weaker economy that imports less.


So, what can you do?

Well, the first thing is insure against a further (and no doubt faster) drop in the dollar.

If you hold dollars, move into something else. You have two realistic options: the Swiss Franc (commonly considered a safe haven) or the British Pound.

Of course, if you live in the U.S., you could stop buying Chinese imports or imports in general. If this doesn't appeal or seems downright impossible then you will understand why the dollar can only go in one direction and you should act accordingly.

Monday, March 14, 2005

Behind the Times

People who sit behind a Times on their way to work are stuck in the past and stuck in their ways.

This is not good for them. But they do it anyway. Why?

Human nature is consistent with people choosing not just an inferior product but one that also costs more than the better alternative.

Perhaps people are paying for the convenience. After all, time is more precious than money. This would explain why fast food has always remained popular despite being so unhealthy. (No coinicidence then that in England, fish and chips are traditionally wrapped in a newspaper, since both are bad for you in different ways!)

So consumers, while driven by their own self interest, do not always act in their best interest.


Newspapers are moving to publish in electronic form only. Once that process is complete, it will be tomorrow's news, not yesterday's, that we are going to have to pay for, whether we want to or not.

Once people become more informed about the world around them the better that world will be.

I guess this was one cheer for the free market...!

Monday, February 28, 2005

How's the service? Terrible?

Service is bad at the best of times. Bad news: it's about to get much much worse. Why?

The internet.

The internet is migrating all of the services we once had to travel somewhere to use. You want to buy clothes? No need to ask you helpful sales assistant about their latest special offers. Just point and click.

But what becomes of the helpful sales assistant? Well, the first thing is, they become a whole lot less helpful. They get trained less and, worse, less motivated to compete with their dot.com colleague.


While human sales assistants are a dying breed, it's the services industry that has been the main driver of economic growth for a large number of the major advanced economies in recent decades.

If a significant (and in recent years, growing) part of the workforce that lies behind a growing economy deteriorates on a mass scale then it signals a major deterioration in a large proportion of the labor force.

Ultimately, it will be the frustration of shoppers in department stores and people on line in Starbucks that will accelerate the complete migration of shoppers from the high street to the internet.


As with all social change, a lot of the change can only be brought about by social forces moving in the direction of that change. The ever-more sloppy sales assistant may well be the last straw.

Or they could just stand up straight, look fast and pretend to be professional!


All of this clearly begs the question, what becomes of all these sales people? This also raises the issue of what to do with all space currently taken by retail outlets.

One possible scenario would be for these buildings to become residential. This would help provide homes where they are most needed: in the inner cities. This might help initiate a new industrial architectural revolution. Such a revolution would resuscitate the manufacturing industry, bringing full circle the changes seen in the 20th century.

Perhaps the hands that serve us in the stores will be those helping to build the homes of the future in the not-too-distant future.

Thursday, February 17, 2005

Goodbye Greenspan, hello inflation target?

In June last year, I explained why the bond market was important.

I'm back to explain why again and also predict what will happen to U.S. interest rates after Alan Greenspan retires from the best job on earth.


In case you hadn't already noticed it's daily movements in the bond market that actually determine the mortgage rates your bank offers you on a daily basis.

If you don't believe me, look at the chart below that shows the 10-year government bond yield (set by the bond market every day) against the 30-year mortgage rate (set by the banks every day).

(Red: 30-year mortgage rate. White: 10-year bond yield)

Most people might think it's the central bank who directly (or even indirectly) set mortgage rates, with retail banks following suit. This isn't how it works.

Firstly, central banks only change interest rates on a monthly basis, if at all. However, banks change the rates they offer to lenders all the time. You might wonder how they can do this if the central bank hasn't changed the "interest rate".

The reason is simple: banks settle their books at the end of every working day by borrowing money at a rate of interest that is being set by the bond market. The bond market sets the interest rate according to expectations of future inflation.

If inflation is expected to increase then interest rates will have to rise in order to compensate bondholders who will see the value of their investment fall in real terms.


As I also mentioned before, the past 2 decades has seen a major crackdown on inflation. This has meant lower interest rates across many countries.

The U.S. is one of the few countries that does not directly target the inflation rate, simply because the person in charge of monetary policy does not want to use a target.

Since Alan Greenspan is expected to leave his post in the near future this raises the possibility that the Federal Reserve will adopt an inflation target as well. This will be very good news for the bond market and more importantly, great news for mortgage holders.

An inflation target means the bond market expects low inflation. Low inflation expectations means low bond market yields. Low bond market yields means low overnight interest rates and this means low mortgage rates.

3 cheers for Alan Greenspan. More cheers for the inflation target!

Friday, February 11, 2005

Tax rant cont.

Three things are certain: death, taxes and more taxes.

The closer you get to death the more in taxes you are going to pay.

As I outlined before, if your income doubles you are going to pay about double the amount of tax.

This is the society's definition of fair since taxes act to redistribute money from one group of society to another; i.e. from the rich to the poor.


As I also outlined before, America has a major problem with saving. The government and the citizens it represents don't like doing it.

If an individual is short of savings they go to a bank to borrow money.

The government goes to the public, by way of taxation. The more money the government needs, the higher taxes go.

The problem facing the U.S. government is an increasing need to fund expenditure by way of taxation. This means taxes will need to rise further.


A commonly heard argument is that people with higher incomes (let's call them 'companies') should be taxed more than those with lower incomes.

This is considered a fairer way to raise the extra money the government needs.

However, since it's companies that hire people on lower incomes, then taxing the rich indirectly taxes the poor.

A company that loses a higher share of it's income to the government will have less left over to hire more people.

You can only go to the well so many times before it eventually runs dry.


The economy runs in a circle: companies make things, people work for companies, people spend money on things companies make.

If one part of this cycle is taxed more than another then it takes away from all other parts as well.

If the government needs to raise more money by increasing taxes it does not benefit any part of society by focusing those increases on certain groups.


In light of the comments to this blog, perhpas this is the best 3D representation of how wealth is distributed amongst various groupings of the economy..

Tuesday, January 11, 2005

The trouble with jdate

These days one Jew isn't expected to marry another.

This is a freedom of choice past generations never had.

However, like most freedoms it isn't one most people today have had to earn. It's the result of years of struggle between parents and children at a time of social change.

Consequently, when one Jew enters into a relationship with another it carries with it a sense of being something special.


JDate gives Jews the 'freedom' to choose from thousands of available people who share the same religion.

It makes it easier for Jewish people to enter into a relationship with one other.

The fact that both people are Jewish can even help sustain the relationship; it can start to feel like eating chocolate without gaining the pounds.

However, this heightened sense attraction to each another can turn out to be illusory:

"What did I ever see in him?"
"He was Jewish?"
"Oh, yeah."


Meeting the right person doesn't always have to be an impossible task. But by making it easier to start a relationship with someone on the basis that they share the same religion is a very sandy beach on which to build the family home.

Too often the relationship will escalate too quickly and then everything comes tumbling down.