“We don’t have a precise read on why this slower pace of growth is persisting.”
Ben Bernanke at his press conference last week following the FOMC meeting.
That was – by far – the most important statement to come out of the post FOMC press conference last week. Bernanke finally had to admit that he doesn’t have a clue why the economy isn’t performing better. I kept seeing a scene in my head of a young Ben Bernanke being questioned by his father.
“Why haven’t you fixed the economy like I told you to, Bennie?”
The list of things that Ben Bernanke doesn’t have a “precise read” on with regard to the economy is long. Of course, no economist has a precise read on all the factors that affect growth in a complex, open economy but Bernanke seems to be particularly illiterate. That Bernanke is finally acknowledging that fact is good news since it might also mean that he’ll stop trying to fix what he doesn’t understand. His attempts so far have done more harm than good in my opinion so if his current confusion is sufficient to get him to sit on his hands for a while, let’s hope he doesn’t figure anything out anytime soon.
One major factor in the recent slower growth has of course been the high price of oil which Bernanke has repeatedly said would be transitory. Well, I guess that is true since high oil prices have preceded many of our past recessions and nothing works to knock down consumption quite as well as lack of a paycheck. Bernanke seems completely unaware that Fed policy has played a large role in the recent rise in oil prices. He also seems blissfully unaware that he has the tools at his disposal to knock them back down. All he has to do is raise interest rates. I guess we can add “How Commodity Markets Work” to the list of things Bernanke doesn’t understand.
Instead of doing the easy thing to knock down oil prices, Bernanke is counting on a release of oil from the SPR to do his job. One suspects that Bernanke knew about the SPR release in advance and believes it will allow him to keep running an easy money policy without suffering the consequences. That the price of oil is not due to a lack of it – there isn’t enough spare storage capacity available for the oil being released from the reserve – has apparently escaped the notice of the folks over at the Fed. The problem is that cheap financing makes it profitable to buy oil, store it and keep it off the market. If Bernanke raised the cost of financing, the problem would be solved. There may be a short term benefit from the release but it doesn’t solve the underlying problem. By the way, I don’t care whether the release is political – it probably is – the US should sell the entire SPR. The government has no more reason to be in the oil business than any other industry.
I don’t know if it was coincidence or planned but the timing of the release must be applauded. When governments intervene in markets it is often in an attempt to change the current trend. In this case though, oil prices were already falling and the SPR release just reinforced the trend rather than trying to change it. That gives it a much higher chance of success. I have been calling for oil to fall anyway with the end of QE II – my target is around $70 – but this may mean an acceleration of the trend and possibly an overshoot on the downside. Make no mistake though, the main problem with the oil markets is monetary policy and until that normalizes, oil and other commodity prices will likely remain elevated – assuming we don’t have another recession soon. A stronger dollar and better economic policy would, I believe, push oil down to as low as $40/barrel. Unfortunately, a stronger dollar is not something anyone in DC seems to want and better policy is looking more and more like a pipe dream.
The transition period I have been warning about for months is still ongoing. The dollar has stabilized while stocks and commodities have corrected. Gold even reacted negatively to the rising dollar last week which I take as good news. The capital tied up in gold might as well be buried in America’s back yard for all the good it does the economy. If capital can be coaxed out of the ultimate safe haven, we might have a chance at better growth. The stock market will eventually find a bottom – it might even be doing so now although I have a sneaky suspicion investors haven’t been sufficiently scared yet – as lower commodity prices are acknowledged as the positive they obviously are for the economy. If you’ve been reading these weekly missives for a while, you probably came into the correction with a good cushion of cash. It might be prudent to start drawing up a list of buys to be put into action when the time comes.
Meanwhile, the economy continues its mixed performance. As has been the case for some time, the data was about evenly split between good and bad news last week. Things are so confused right now that even reports on the same subject come up with different results. The Goldman and Redbook reports on same store retail sales last week pointed in exactly opposite directions. The Goldman report showed a week to week fall of 0.7% and a year over year gain of just 2.2%. The Redbook report on the other hand, reported a good week that pushed the year over year gain to 4.2%. Goldman said Father’s Day was a bust while Redbook said it was gangbusters. I would just point out that both reports show year over year gains which continues to demonstrate that consumption is not the problem with the US economy.
The news wasn’t as mixed on the housing front with both existing and new home sales down in May. Existing home sales are down 15.2% year over year which is an acceleration from the miserable 12.9% contraction reported last month. The absolute supply is just 3.72 million but the weak sales pace puts that at 9.3 months of supply up from last month’s 9 months. New home sales were also down 2.1% from April and over 20% year over year. Frankly, these numbers are so low as to be almost meaningless. Supply is down to just 166,000 units which is the lowest on record going back over 50 years. The problem with housing is of course the jobs market which also didn’t get any good news last week with jobless claims rising to 429k. Until that number falls below 400k and keeps falling, unemployment is unlikely to improve much.
The good news of the week came in the form of Durable Goods orders which rose 1.9% in May. This report is volatile so just as last month’s fall wasn’t anything to get excited about neither does this one make a trend. It was a good report though with broad based gains. Transportation orders were up big but even excluding volatile aircraft orders, orders were up 0.6%. Autos were still weak but higher. More important, non defense capital goods orders excluding aircraft rose 1.6%. This is an important indicator of capital spending and points to continued interest in corporate investment. In an economy where investment in structures – residential and non residential – is still depressed, corporate investment becomes that much more important.
First quarter GDP was revised slightly higher to 1.9%. For now, I see no reason to believe that things have changed much from that growth rate. Investment in housing has, if anything, gotten worse while corporate investment is still rising but is far from robust considering the cash available on corporate balance sheets. Consumption hasn’t changed appreciably either. The one thing that did change in the second quarter was inflation. The first quarter GDP report used a 2% inflation number and I expect that will be higher for the second quarter. That it is old information and inflation rates have peaked since then doesn’t change the fact that it was higher during most of the quarter. When GDP is reported next month the likelihood of a downside surprise is high. And Bernanke still won’t have a clue what caused it.
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