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The Blue Money Report
"The knowledge of an effect depends on and involves the knowledge of a cause."
~ Spinoza

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Today's Commentary: 08.22.03
Returning to Max
Last week, I toyed with the idea of taking the basic tenets of Max Planck's theory of quantum mechanics and applying it to the steady stream of numbers that are released for the market's purusal. For those of you who missed that column (an excerpted version can be found here), we took energy, position, momentum, size and time as the economic filter for the recent unemployment figures and the seemingly contradictory productivity number. The end result of that basically was a wash. The economic impact of new claims literally canceled out the improved productivity numbers as we hypothesized that workers who had jobs were working harder to keep those jobs.

So it is time to see if this will work with the recent housing numbers and the overall confidence of the consumer as reported by the Michigan survey. These numbers have both changed drastically over the course of the year as the markets have turned bullish. Now, with the market in equities moving in a less enthusiastic manner and the bond market sell-off losing steam and balancing somewhat, can we read something into these numbers as a predictor of good or bad times ahead?

Both of these numbers unfortunately lack energy. Energy is crucial in our thinking. New housing starts were up markedly in this latest report giving investors and nay sayers something to consider. There has been a good deal of talk about the presence of a housing bubble, which based on what we have determined, doesn't exist. New home starts rose dramatically but this doesn't represent a sudden glut in inventories. In fact, the 1.933 million starts represents an increased optimism among home builders but not an increase in supply. New homes have been built cleverly keeping a pace that falls just short of demand. And although this number is the highest reported in 17 years, it is still not outpacing the need of the consumer.

Which contributed to the decrease in the recent University of Michigan's consumer confidence. While anything the decreases can be considered a negative, this number actually reflects a mental re-adjustment of sorts for the consumer. Surveys taken immediately after the Iraqi war were quite upbeat by comparison but the economic impact of that conflict, the recent Fed stance and the upward tick of long term interest rates have left much of the 60,000 households surveyed with a slightly less positive outlook.

Running these numbers for momentum is slightly more difficult. If the energy of these numbers are offset, the momentum should by all accounts run slower also. But that is not necessarily the case. Housing is a necessity but homeownership is not. Much of the recent push to buy has been a result of lower interest rates and higher rents. Those rents have been adjusted keeping more potential buyers on the sidelines as they ponder the economics of their decision. Interest rates have risen and those that have been wavering have locked in their rates. Those that have not, the survey reports, are feeling as though they may have missed their best opportunity to buy. Instead of slowing, the momentum in both of these numbers will accelerate as builders continue to be just shy of meeting demand and consumers will be forced to purchase loans at rates much higher than they would have liked.

We looked at position as the price in our previous comparison. In this instance we will look at it as pricing power. Clearly the builders have the upper hand in this arrangement. Keeping demand high and supplies low, the rise in rates from a June low of 5.21% to an August rate of 6.28% will impact refinancing more than new loans. Those who can will find a way, even if it means using some newer and more innovative methods of borrowing. This however will not be the best environment for first time buyers with limited credit ratings. These folks, as represented in the consumer numbers may decide to shelve the idea in the hopes that interest rates will fall again as opposed to rising. The increased cost of the loan will play havoc with folks who are teetering on the financial edge which will probably slow the recent increase in foreclosures.

These numbers, for the sake of our economic filter lack size and the markets on both sides reacted in a lukewarm fashion. If you never bought into the notion that we faced a crisis in home building and never quite believed in the existence of a bubble, you were nonplussed by the data suggesting that the recovery can be seen in housing. There is no bubble. Any hint of one was seen as being regional as opposed to nationwide. Consumers see this as as a double edged sword although. New homes in certain areas have remained affordable while existing owners have found it difficult to join in the refinancing boom. These folks, caught in pockets of stagnation have seen the value of their homes increase slightly if at all. In some instances, particularly in the midwest, home appreciation has barely kept pace with inflation.

And lastly we look at time. It has been almost seventeen years since new housing starts reached this level. The world was a much different place then. We had yet to fight two Gulf wars, we had yet to experience a drastic change in monetary policy from "Whip Inflation Now" or WIN as the buttons of the day reflected to a reflationary accommodation or as Alan Abelson and Randall W. Forsyth suggested in Saturday's Barron's, to SIN or "start inflation now". As long as the interest rates inch up increasing the pricing power for builders, supplies will stay just shy of demand and consumers will be just shy of comfortably accepting the increase.

While energy was lackluster, momentum was upbeat. While position was changed to reflect the urge for inflationary pricing, the size of the change in these numbers require some reading between the lines. And lastly, the effect of time and the change in attitudes from one quarter to the next suggest that these numbers may not be worth a second glance if you are trying to find some solid economic footing. Consumers will remain somewhat downbeat as they remain somewhat jobless. Housing will remain much the same as long as builders continue to hold on to their formula of allowing only some to reach the dangling carrot.

Today's Commentary: 08.19.03
Making Money Worthless
What do you do if you're the Federal Reserve Board and you feel the specter of deflation creeping in the shadows? What do you do if you can find a reason to revive a former solution to a very different problem? You do it without fanfare. You do it without seeming to have done it and you simply change the names of the players to reflect the changing times.

The policy I speak of is called the Plaza Accord of 1985. The world was a very different place back then as I mentioned earlier. An excerpt from the Accord points to one of the underlying reasons such a policy was created:

The interaction of these factors-- relative growth rates, the debt problems of developing countries, and exchange rate development-- has contributed to large, potentially destabilizing external imbalances among major industrial countries. In particular, the United States has a large and growing current account deficit, and Japan, and to a lesser extent Germany, large and growing current account surpluses.

The factors they speak about are deflationary pressures that would be put on developing countries as the U.S., Japan, and Germany in this instance were experiencing growth which could have thrown the whole global market out of whack. While goods were being priced correctly here at home, other countries would have been unable to create any cash flow because of the deflationary pressure on their own goods. No money coming in means development slows which means that growth slows which means that the customers these three economic powers sought for their own goods would disappear.

Now switch if you will the players, although you don't have to change many folks at the table. Alan Greenspan was there as Ronald Reagan's Economic Advisor, Japan hasn't really ever recovered from the aftermath of the treaty, and Germany is no longer a stand-alone power replaced for the sake of updating by the Chinese.

Now let's drag the whole affair into a post-recessionary period of 2001. Alan Greenspan has destabilized the economy with the gradual lowering of short-term interest rates. He arrived at a 41 year low recently and even more recently, he and the gang at the F.O.M.C. have decided to keep them that way to keep the evil D at bay. But there is no evil D and I suspect that there never was one.

By suggesting that he would do anything to battle this possibility he led the way to a policy that in the long term will be far more damaging that the economy that we can really afford. When Fed Governor Bernie Bernanke suggested late last year that the Federal Reserve was planning on keeping the money supply full by churning out the greenbacks at full tilt, he was doing so to keep you from noticing why.

One more quick switch to the landlords. That's right. Those folks who collect the rent each month. These guys and gals understand that to make money you need to keep the buildings full. They had been lax in doing this and slow to react, thinking that those dropping long term interest rates would not be sufficient enough get those renters off their collective duffs and buy a house of their own. So they kept rents high too long as they watched the vacancy rate climb. This believe it or not helped the Consumer Price Index during those recessionary months because this figure is included in the core CPI number that excludes energy and food. But that is not the case anymore. Rents are starting to climb again after dropping somewhat even as long-term rates begin to climb. This took that relatively comforting number of 2.11% down to an adjusted 1% or so, which is better than a negative. Remember that CPI number, it comes in later.

So we have a sign that prices are doing okay. Not great, but not running in the red either. And we are able to buy anything we want in the global market because we can print money at will and with very little in the way of real cost. Then the surprising effect of the printing press is that the money comes right back to us in the form of loans. We print it, spend it, and then we get it back by borrowing it fro the same folks that sold us the goods! This is just good stuff so far.

The other countries in turn buy such things as mortgage backed securities, which help us refinance and/or buy homes. It goes to help the President continue his quest at creating the wrenching deficit and it helps the good ol' U.S.A. pay off our own debts. These other countries are doing themselves a favor also. They keep their own money from becoming too expensive by keeping the dollar strong and they grow their supply as well.

All courtesy of printing presses at the Fed. So who's buying? China and its reclaimed center of Far East wealth, Hong Kong have become the primary buyers, that's who. And by pumping almost $300 billion into this scheme they have kept their own deflation down. Japan, the hardest hit in the post-Plaza Accord world has needed to do much the same to keep the value of their yen under control.

But our homeland economic woes may not have ever been much more than the fevered imagination of the Fed chief. Inflation is returning in a slow methodical way and this is because the landlords will be able to lift the ceiling on rental rates faster. Home loans were selling fast and furiously as those clever souls who locked in before the rates began to rise jumped at the chance to close the deal creating a good deal of new mortgage backed securities. Those poor renters may feel as though they have missed the chance of a lifetime. These folks, if they continue to entertain that sort of ennui will be forced to stay renters a little while longer. Landlords are not going to wait long before they begin to accelerate their contribution to the core CPI number.

So as they big monetary players continue to break the law with quiet abandon, the fallout will solely be those of us who do the dirty work. We earn the money, which is really worthless, we pay the rent, and we try to stash a little away for the future. The current enactment of the Plaza Accord will have the same disastrous effects on our economy as it did on the Japanese. They are still paying the price.

Our payment for the policy came with the fall of the stock market in 1987 which eventually took the overbought dollar and the overpriced bond market down with it. Does this sound familiar?

To tidy things up a bit, I should clarify several statements I have just made. Earlier I suggested that the gradual reduction of the short-term interest rate had a destabilizing effect. William Waitzman in a recent issue of Barron's pointed out the pattern in the GDP. Over a five year period of either high or low interest rates, the GDP remained constant. When those rtes were adjusted, the GDP seemed to come under pressure. He also suggested that the bond market could do just as well setting short term rates as it does setting the remaining rates.

The CPI number is an important contributor to the yield of Treasury Inflation Protected Securities or TIPS. Mentioned here last week as the one sure bet in the conservative bond market and a place Bill Gross, head bondmaster at PIMCO wished he had reacted to sooner; the yield on these bonds can be quite nice as the CPI climbs. In other words, the very inflation that the F.O.M.C. wants is already growing without all of the financial finagling. Mr. Waitzman suggested that Fed just close up shop and leave things alone.