Interest Rates

…and the Fed’s manipulation of them. Sober Look has six thoughts on the matter (though they don’t couch it in terms of manipulation), and so do I.

  1. While the Fed officially talks about not being focused on the currency markets, the recent dollar rally should give them some food for thought. The global “currency wars” have sent the trade-weighted US dollar to the highest levels in over a decade. This will continue to put pressure on US manufacturing (and even some services sectors) as US labor and other costs of production rise relative to other nations.

Not that much. Manufacturing, per se, hasn’t been that big a deal for our economy this century, for all that it’s making a useful comeback lately. Too, the “currency wars” are a response to the PRC’s revaluation and have mostly played out. Most importantly, the “highest levels in over a decade” isn’t all that high, even in relative terms. This is a factor that’s largely irrelevant.

  1. Commodity prices, led by crude oil and industrial metals, hit new multi-year lows, reigniting disinflationary pressures. Note that the Bloomberg Commodity Index is at the lowest level since 2002.

To the extent this is applying any pressure at all, it’s a deflationary one—and so a reason to raise interest rates, an inherently inflationary move, since rising interest rates are intrinsically inflationary.

  1. Driven to a large extent by commodity prices as well as economic weakness in China, US breakeven inflation expectations are declining sharply as well.

This is another who-cares concern. The breakeven inflation rate is the difference in yield on Treasury debt and TIPs of the same maturity that makes an investor not care which he buys; he gets the same yield. Both Treasury and TIP rates vary with market pressures (or would were the Fed not artificially suppressing rates), and so the only effect here is lag between one moving and the other moving to compensate.

  1. Some point to the recent stability in “core inflation”, with CPI ex food and energy remaining around 1.8% and providing support for a less accommodative policy. However the main driver of this stability is the rising cost of shelter. Core CPI excluding shelter is below 1% (YoY [year-on-year]).

One of the Fed’s dual statutory mandates is price stability, and the Fed has defined the inflation rate safely consistent with that to be 2% inflation (YoY). Inflation has been below that for lots of years because the Fed has artificially suppressed interest rates instead of letting them answer to market forces. As noted above, rising interest rates are inherently inflationary; if we’re to get to the Fed’s 2% target, interest rates need to be allowed to rise to levels historically consistent with 2% inflation.

  1. The biggest argument for a rate hike is the expectation of increasing wage pressures. US labor markets continue to improve and at some point – the argument goes – wage growth will accelerate. However, we haven’t seen much evidence for wage pressures thus far, as average hourly earnings continue to grow by about 2% per year (nominal). With the recent dollar strength, US corporations will speed up shifting production abroad – especially Mexico, limiting wage growth in the United States.

Sober Look is, in the main, right on this. Which puts the thing in the who-cares category. Sober Look does expand on this by worrying that stagnant wages coupled with higher interest might start to price renters out of their rented homes. An interest rate régime consistent with the Fed’s target inflation rate won’t present that risk though. What will present the risk is a separate problem of the Fed’s creation, and that’s the enormous inflationary pressure it’s created with its excessive money printing since 2009.

  1. Finally some at the Fed have been concerned about bubbles forming in the financial markets. In recent weeks however, the markets took care of that, as a healthy dose of risk aversion returns to the markets[.]

As they say. And so this is a who-cares item.

In sum, my thoughts center on sticking to a plan and a rate rise/release is necessary for one reason or another. Raise the rates/let them float (at least a bit more) in September as planned.

Energy Wealth Redistribution

Your tax dollars at work. Exposed by UC Berkeley, yet. This is the Abstract from their working paper The Distributional Effects of U.S. Clean Energy Tax Credits [emphasis added]:

Since 2006, US households have received more than $18 billion in federal income tax credits for weatherizing their homes, installing solar panels, buying hybrid and electric vehicles, and other “clean energy” investments. We use tax return data to examine the socioeconomic characteristics of program recipients. We find that these tax expenditures have gone predominantly to higher-income Americans. The bottom three income quintiles have received about 10% of all credits, while the top quintile has received about 60%. The most extreme is the program aimed at electric vehicles, where we find that the top income quintile has received about 90% of all credits. By comparing to previous work on the distributional consequences of pricing greenhouse gas emissions, we conclude that tax credits are likely to be much less attractive on distributional grounds than market mechanisms to reduce GHGs.

Of course, the top quintile aren’t only the cronies; they’re also the folks rich enough to install these things and/or buy the expensive battery-operated cars—which are horribly expensive, even after the “tax credits,” and in the case of those solar panels, have payback periods measured in generations rather than years.

From the body of the paper [citation omitted]:

If these tax credits are successful in inducing changes in behavior, then we should expect to see increased purchases during years in which the subsidies are particularly generous. Conversely, if credits do not induce additional sales, then the primary effect is just to transfer rents to participants in transactions that would have taken place anyway.

In other words, if there are no additional sales, then the sales that would have occurred anyway would see wealth redistribution from the lower income strata to the higher income strata in addition to the basic price paid for the goody bought.

How did that work out? Taking, for example, hybrid car sales,

There does not appear to be much of a decrease in hybrid sales when the AMVC [Alternative Motor Vehicle (Tax) Credit] was ended for all hybrids at the end of 2010. Moreover, since 2010, hybrid sales have increased significantly without the benefit of the AMVC.

Hmm….

From the paper’s conclusion:

Since 2006, these credits have provided more than $18 billion in subsidies for households who make clean energy investments. Using rich data from tax returns we show that over the last decade US clean energy tax credits have gone predominantly to higher-income Americans. Taxpayers with AGI in excess of $75,000 have received about 60% of all credit dollars aimed at energy-efficiency, residential solar, and hybrid vehicles, and about 90% of all credit dollars aimed at electric cars.

Again, hmm….

School Lunches

Apparently our school kids are eschewing critical parts of the First Lady’s Federally mandated (via the Healthy, Hunger-Free Kids Act) school lunch menu. A University of Vermont research report says that the kids are tossing their veggies after they’re forced by their schools, under the Act, to select one (or a fruit), rather than actually eating them.

The report, entitled Impact of the National School Lunch Program on Fruit and Vegetable Selection, noted that average waste increased from a quarter cup to more than one-third of a cup per tray.

A USDA spokesman said,

Ninety-five percent of schools are successfully serving healthier meals….

Nice try, Mr Alinsky, but we’re talking about what the kids are eating, not what you’re serving. Besides, you’re apparently serving those veggies to the trash can.

Much Ado about Nothing

Many traders reported difficulty buying and selling exchange-traded funds, a popular investment in which baskets of stocks and other assets are packaged to facilitate easy trading. Dozens of ETFs traded at sharp discounts to their net asset value—or their components’ worth—leading to outsize losses for investors who entered sell orders at the depth of the panic.

Products built to provide insurance for investors came up short. As a result of trading halts in futures tied to the S&P 500 index, it was difficult for investors to get consistent prices on contracts linked to them that offer insurance against S&P 500 declines.

That’s how Bradley Hope, Saumya Vaishampayan, and Corrie Driebusch opened their Wall Street Journal piece about Monday’s stock market performance, a piece interestingly titled Stock-Market Tumult Exposes Flaws in Modern Markets.

They also had this:

The giant swings in the market and problems with ETFs pointed to a need to rethink rules governing stock trading, analysts said.

“There needs to be a deeper examination of how the stock-market circuit breakers behaved on Monday,” said Joel Dickson, a senior investment strategist at Vanguard Group of Valley Forge, PA. “There was a major market-structure component to what happened.”

Illustrative of the bleating is this, too:

“Pricing options is almost impossible on the kind of move you had that day,” said Wayne Wu, who trades SPDR S&P 500 ETF options on the NYSE floor for Integral Derivatives.

Yeah, and? If an investor can’t get/doesn’t like the data related to an investment plan, it’s on him to take the risk, or not. It’s not on government to protect him from the outcomes of his decisions.

More government rules, or more layers on existing ones? No. Fewer government rules, and simpler. Tumult is the necessary noise of a free market. The PRC’s failure is illustrative of the outcomes of government “management” of markets and of underlying economies. We’re not where the PRC is, yet, and we don’t need to approach that, either.

But, but–what about guys who already had staked out positions when this happened, when the information breakdown occurred?  Second Rule of Investing (the First Rule is “Never invest anything you can’t afford to lose all of”): “Know where the back door is before you go in through the front door.”

Personal responsibility. Government needs to butt out. Caveat emptor.

EPA’s Orwellian Transparency

Congressman Lamar Smith (R, TX), Chairman of the House Science, Space, and Technology Committee, is unhappy with the EPA’s decision to be unresponsive to Committee requests for information regarding the EPA-caused disaster in and downriver from a Colorado mine.

It is disappointing, but not surprising, that the EPA failed to meet the House Science Committee’s reasonable deadline in turning over documents pertaining to the Gold King Mine spill. These documents are essential to the Committee’s ongoing investigation and our upcoming hearing on Sept 9. But more importantly, this information matters to the many Americans directly affected in western states, who are still waiting for answers from the EPA.

But that’s just transparency in the manner of this administration.