Broken Velocity: Yellen’s Low Inflation Quandary (Hint: FHFA Home Price Index Growing At 6.62% YoY)

Here is a brief summary of Fed Chair Janet Yellen’s thoughts from yesterday courtesy of Deutsche Bank’s Peter Hooper: The Fed is on track to raise rates once more this year and three times in 2018. Yellen recognized that inflation has been running low recently, and that while there was some uncertainty around this performance, one-off factors that are not expected to persist, and which have not been associated with the performance of the broader economy, have been important. At the same time, Yellen noted that monetary policy operates with a lag and that labor market tightness will eventually push inflation up.

Inflation has been running low “recently”? Actually, “inflation” (defined as core personal consumption expenditure price growth YoY) has been below 2% since April 2012 and below 3% since July 1992. Notice that hourly wage growth for production and nonsupervisory employees has remained low as well, particularly since 2007.

Of course, home price increases have been far greater than the “inflation” rate used by The Fed. The recent FHFA Purchase-only home price index YoY (released this morning for June) has US home prices growing at 6.62% YoY while “inflation” is growing at a palty 1.40% YoY.

But nothing really seems to be working as expected by some. Expanding the M2 Money Supply was supposed to increase Real GDP, but that really hasn’t worked since the Reagan/Clinton recovery when M2 Money Supply growth dropped from over 12.5% YoY in 1983 to 0.1% YoY in April 1995 under President Clinton and Federal Reserve Chair Alan “Maestro” Greenspan. Robert Rubin was the Treasury Secretary.

Notice that M2 Money growth has almost always been higher than real GDP growth since 1995. Hence, M2 Money Velocity has mostly been declining since 1997.

What about the old model where additional Federal debt is okay as long as real GDP growth is greater than Federal debt growth? We are nearly at that point again after decades of rapid Federal debt growth with modest real GDP growth.

I am guessing that rather than raise rates next year, The Fed may be forced to expand their balance sheet … again. Giving more oxygen to the asset bubbles.

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As many Americans are forced to switch from exotic beers like Heineken to less expensive beers like Pabst Blue Ribbon. 

 

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The Austrian Solution: Austria Issues 100 Year Sovereign Bond (100 Years at 2%?)

Sadly, Congress has absolutely no controls on the willingness to spend money and promise entitlements to borrowers. Spending is a runaway trend in Washington DC.

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Much of this spending is entitlement spending, such as Medicaid and Medicare.

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The explosion of Federal spending and entitlements will eventually recover an Austrian solution: 100 year debt. Until recently, Austria already led nations with the longest sovereign debt maturity of 70 years. Most other countries are at 50, 40 and 30 year maturities.

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The deal — which was priced at a yield of 2.112 per cent — is the eurozone’s first syndicated century bond. Belgium and Ireland each raised €100m in century bonds last year but those deals were private placements rather than open market offerings. Their issuance is part of a wider trend: governments around the world sold a record $63.5bn of debt with ultra-long maturities in 2016, according to figures from data provider Dealogic.

Does America issue 100 year Treasury bonds? No, how about 120 year bonds?

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US Debt Ceiling, The Wall, Runaway Spending And The Lack Of Evidence Of Concern … So Far (Low US CDS)

The US Statutory Debt Limit, a failed tool to halt the endless growth of Federal debt issuance, is once again in play at nearly $20 trillion. It was only at $6 trillion in 2002.

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The problem, of course, is runaway Fed spending which is currently at around twice that of Federal current tax receipts, requiring that the deficit be funded by issuing Federal debt (or raising taxes and/or cutting Federal spending).

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The staggering increase in Federal debt starting in 2007 also resulted in a large spike in public debt to GDP.

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The US has joined the European PIGs (Portugal, Italy, Greece, as well as Cyprus and Belgium) in having debt as a percentage of GDP being over 100%. The fourth debt piggie is Spain at 99.40% debt to GDP.

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The core problem with Federal spending, now and in the future, is mandatory (entitlement) spending.

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Of the entitlement spending, Medicare is growing at an unsustainable rate (although Medicaid growth is no slouch either).

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So we are on an ussustainable track in terms of spending. How does “the wall” with Mexico fit it? It could be funded with more taxation, or spending cuts on other programs. Democrats LOVE raising taxes, but not to build a wall. Republicans are split on building a wall (open border freemarketeers versus those with national security concerns).

My colleagues at my former employer Deutsche Bank have attempted to lay out possible funding scenarios. Although I think the odds of deep spending cuts is about as likely as North Korea embracing personal freedom and capitalism.

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With explosive Federal spending and projections of public debt exceeding first $20 and then $30 trillion, I have little doubt that Congress and President Trump will agree on a debt limit increase even if there is a momentary government shutdown.

But right now, credit default swaps are signaling no shutdown, particularly in comparison to previous shutdown fears surrounding debt ceiling increases (orange boxes).

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So, there is nothing YET showing up in the CDS data. We are seeing an increase in Treasury bills rates even when the probability of a Fed increase in their rates is very low for the next year.

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The probability of a US default is around 0.04%.

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But there is also a realization that while there was intial enthusiam that Trump would lower taxes and deregulate the economy,  there is has a steady decline in enthusiasm over his promises since Congress is obstructing most of Trump’s economic agenda.

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We can hope that Congress and President Trump follow the advice of the band Canned Heat and work together. 

But we do know that Congress loves to spend money, so they have a natural mutual allegiance to raising the debt ceiling.

Perhaps Andy Dwyer and Mouserat from Parks and Recreation can rewrite their song “The Pit” as “The Wall.”

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M2 Money Velocity Continues To Collapse Since Monetary Change of 1995

M2 Money Velocity (better known as GDP/M2 Money Stock) continues to collapse. In fact, M2 Money Velocity hit its peak in Q2 1997 under President Bill Clinton. And it has been mostly downhill since then.

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One interesting aspect of monetary policy during the Clinton years, specifically in 1995. Proir to 1995, real GDP growth YoY actually exceeded M2 Money growth YoY.  Ever since 1995, M2 Money growth has almost always exceeded real GDP growth.

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As of Q2, the ratio of M2 money growth to real GDP growth is over 2x.

Given that Federal government current expenditures is currently around 2x Federal government tax receipts, it seems that The Federal Reserve is following a 2x rule.

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Yes, things have really gone off the rails since 1995 when you have a combination of President Bill Clinton, Fed Chair Alan “Maestro” Greenspan and Treasury Secretary Robert Rubin (CEO of Citi) running the show.

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M2 Money Growth Declines To 20 Month Low (What Happens To Wage Growth?)

Real median household income, one measure of American household prosperity, peaked in 1999, fell slightly in 2000, then declined in the early 2000s only to hit decade-peak in 2007. RMINC continued to fall again until 2012 when it finally started to rise.

What is notable is that the rise in real median household income in the 1990s corresponded with a rapid rise in the M2 money supply.from 1995 to 1999. That represented a 33% in M2 money supply.

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The rapid increase in M2 Money Supply also corresponds to the high in M2 Money Velocity in 1997, as if Fed Chair Alan Greenspan expended all the M2 fuel in one massive attempt to stimulate the economy.  M2 velocity (GDP/Money Supply) has been falling ever since. Along with real median household income. EXCEPT FOR 2013 AND AFTER WHEN REAL MEDIAN HOUSEHOLD INCOME ROSE EVEN AS M2 MONEY VELOCITY WAS SINKING LIKE A ROCK.

One possible explanation lies with the redesign of the income question in 2013 and onwards.

Starting in 2013 with a partial phase-in, which was fully implemented in 2014, Census changed the questions and the methods in calculating household income.

For example, Census, starting in 2014, began to “collect the value of assets that generate income if the respondent is unsure of the income generated.”

Also, the government started to use “income ranges” as a follow-up for “don’t know” or “refused” answers on income-amount questions.

So, that is a partial explanation for the anomoly of rising real median household income with crashing M2 Money Velocity. THEY CHANGED THE HOUSEHOLD INCOME DEFINTION.

M2 Money growth has fallen to a 20 month low  while an alternative measure of money supply, the Austrian money supply, just fell to a 105 month low. 

The “Austrian” measure of the money supply differs from M2 in that it includes treasury deposits at the Fed (and excludes short time deposits, traveler’s checks, and retail money funds).

Well, M2 Money supply increases hasn’t done much for Average Hourly Earnings of Production and Nonsupervisory Employees, particularly since 2008.

Whether we are using the decline in M2 growth or Austrian money growth, neither one have benefitted the majority of Americans.