The Sky is Falling, The Sky is Falling...and QE2 is to Blame!

            The “sky is falling” inflation fears are a recurring theme nowadays thanks to a group of “inflationistas” running around screaming about runaway inflation and the imminent collapse of our economy. Any attempt to quell their fears with references to the CPI-U and BPP result in a unilateral dismissal of any index that contradicts the impending end of our currency. And who is the villain behind our impending doom you ask? "The Fed and its QE2 policy", say the inflationistas which has “printed” trillions of dollars in a misguided attempt to jump start our economy.

            There is no debating the existence of inflation within our economy a fact supported by both the CPI-U and the BPP. What is debatable is the runaway inflation (or hyperinflation) that the inflationistas say we are currently experiencing as a result of the second round of quantitative easing (QE2).The CPI and BPP report very modest levels of inflation but inflationistas retort that the CPI is a government manipulated index that clearly isn’t accounting for the inflationary effects of QE2 on our currency. After all how can you print trillions of dollars in new currency and not expect there to be inflation?

The fact that Japan, whose recent economic problems are very similar to the U.S.'s problems, used a quantitative easing policy through the early part of the century with no inflation (Japan continues to suffer deflation) should be an indicator that quantitative easing and inflation are not synonymous. However for the sake of argument lets dismiss the Japanese historical precedent and assume that Japan and the U.S. economic situations are too different to be relevant.

            Inflationistas are shocked to learn that the trillions that the Fed has reputably “printed” haven't been printed at all. Printing money is usually associated with the monetizing of a nation's debt (think Weimar Germany) which is not in fact what has occurred with QE2. The money was created electronically and credited to the accounts of those banking institutions that are members of the Federal Reserve system in a bond purchasing program.Combined with low interest rates the bond buying program was designed to increase liquidity at commercial banks and promote lending (credit easing) and thus start the recovery. The ultimate result of all of this is to reduce unemployment and maintain a very slow level of inflation.

Graph 2 Lending from Comm. Banks

Graph 1 Reserves Amounts

           However the money that was created and put on account for the banking industry to date hasn’t been used (similar to what occurred in Japan). Instead those funds are sitting on account at the Federal Reserve earning interest for the holders of said accounts. Apparently commercial banks have decided to either leave the reserve fund that are earning them interest or simply refrain from loaning the money and instead are putting it into short-term treasury bonds. To support these facts see graphs I and II. Graph I shows the reserve amounts sitting on account within the Fed for commercial banks and graph II shows the downward trend of lending. The slight up-tick in graph II during 2010 is most likely a result of QE2 efforts but the trend is downward again. (All Graph information provided by FRED)

           We have the part of the answer to this problem but cannot finish until we discuss inflation itself.

Inflation has many definitions but the most common states that inflation is a sustained rise in the price of goods and services over time. From my vantage point though this definition doesn’t show inflation’s true colors so I prefer the old adage inflation is “too much money chasing too few goods”. The key word here is “chasing” because the amount of money that you have in a given system is irrelevant if that money isn’t being spent “chasing” goods. The “chasing” portion is expressed as velocity of money and without velocity there can be no inflation.The importance of velocity can be easily illustrated.

Let’s suppose that the Fed electronically creates 200 trillion dollars and credits my account with that money. I go in, see the money but never spend it. The money supply has expanded dramatically but there hasn’t been any inflation because the money created isn’t chasing any goods. This is a demonstration of lack of velocity and reveals the true nature of inflation. You can expand a money supply dramatically but if that money isn't being spent chasing goods you end up with little to no inflation at all. Or even worse yet you end up with deflation (again reference Japan).

            If we recall graph 1 the money created by QE2 is sitting on account for the banking industry and combine that with graph 3 showing that money velocity is at a 20 year low the idea that we haven't entered a period of runaway inflation becomes highly probably and the CPI's and BPP's numbers plausible even if you are skeptic.

Graph 3 Velocity of the M2. Courtesy of Fed. Reserve.

  Referring back to the scenario above let us suppose that I decide to use that 200 trillion to pay off some old debts. I send 10 trillion dollars to 20 banks that I owe money and call it day happy that I no longer have debt. Worried about the current economic state and my job I decide it is best not to do anything but sit back and wait to see what happens. The banks receive the money I owed them and happy to have the debt paid off decide to call it a day and leave the money in their accounts to earn interest. Everyone has effectively de-leveraged themselves and has decided to no longer borrow or lend money. There has been limited turnover but very little in the way of velocity. No risk has been taken, no loans made, money borrowed so the trillions haven't made their way into the economy to chase goods.

            Based on the above facts and situations it is easy to understand why despite a considerable expansion of the money supply there hasn't been any severe inflation. Of course this doesn't remove the threat of inflation but it does help explain why the CPI-U and BPP's inflation numbers are at their current modest levels. As money velocity picks up and bank lending and consumer spending resume the Federal Reserve will be forced to combat inflation and remove liquidity from the system. There is a number of methods through which this can and will be accomplished that probably deserve a blog of their own.That said quantitative easing and inflation are not synonymous and both our current predicament and Japan's history demonstrate that effectively. In fact the best argument against quantitative easing is probably the fact that in Japan it did very little in the way of jump starting the economy and causing any inflation at all.

         

With Bated Breath

               Enemies of Governor Chris Christie are holding their collective breath for a Supreme Court decision that will be made Tuesday morning on the legality of state school funding cuts. In the balance sits circa 1.7 billion dollars worth of school funding that was removed over the last 1.5 years by the Governor screaming budgetary deficits.

                When the decision is released tomorrow Governor Christie will either be enjoying a political victory or a calamitous defeat. 

     Any victory for the Governor on this issue may prove to be pyrrhic in nature as it comes at the cost of deteriorating public schools which will ultimately affect a whole host of other issues social and economic.  

                A defeat will provide enemies of Christie the ammunition that they need for a powerful salvo against his social and economic policies. A defeat also provides the first ingredient for what has the potential to be a financial perfect storm for a state that has already been staggered by budgetary deficit problems and a host of other issues.

                From my vantage point I believe the court will order the restoration of at least part of the funds which will probably result in a financial crisis for the governor as he faces further budgetary shortfalls or refusal and probable impeachment.

Please, No More Dog and Pony Shows!

In its weekly report the EIA has indicated that crude oil and gasoline stocks remained at the level they were the week before. Shockingly the price of crude on the NYMEX has begun to rise and is currently back over $100 p/bbl. ** Since this posting oil dropped back under $100 p/bbl **

The International Energy Agency indicated in a report today that rising energy prices are affecting the global recovery from the Great Recession and that oil exporting nations should increase production to offset the recent price surge. In summary the IEA points out that high oil prices help neither producer or consumer nations and that a move to ease the financial burden by increased oil production should be undertaken sooner rather than later.

One thing for sure will continue to happen here in the United States,  politicians will continue to posture and make idle threats while middle-class America and the poor around the world bear the brunt of the increased cost and decreased discretionary income vital to an global economic recovery.

What has shocked me is the lack of leadership on all levels from our government in addressing the problem.

The President has been all but lame on the issue convening a Justice Department investigation that was nothing more than lip service to the U.S. public. If the Justice Department didn't throw bankers in jail after the Mortgage-Credit crisis what are they going to do to Big Oil and bankers now? (Maybe a good talking to is in order) It should be added that if President Obama would empower the CFTC to do their job the rise in the price of oil caused by speculation would already be under control and he could save taxpayer dollars for this impotent investigation.

Congress' efforts to threaten oil giants all but blew up in their face last week with Big Oil execs firing back about how they need tax subsidies to be competitive and profitable. Logic dictates that any reduction in subsidies or increase in taxation will only be passed along to the consumer without some form of price control. The last time there were price controls on oil was when Richard Nixon was in office and I doubt that President Obama or Congress will step up to that plate again.

So where is the real leadership from our Government and not the Dog and Pony Show that Congress alluded to last week? 

• Where are the increases in MPG requirements for car manufacturers beyond what we currently have? Now is the time to push them through while public support is there. 
• Why are we not funding conversion to liquid propane powered vehicles or another alternative fuel source beyond oil?
• Where are moves to regulate oil trades and reduce or eliminate speculation beyond those that actually utilize oil i.e. airlines, trucking companies, farmers etc. etc.? 
• Where are the threats of price ceilings and further regulation of the oil companies themselves? 
• Where are the permits for drilling on the OCS? Just because BP and co. didn't follow regulations and accepted guidelines doesn't mean others won't?

 Increased energy costs will continue to hamper and slow an economy with 9.4% unemployment. Many of the issues that Democrats and Republicans are currently fighting over are moot without an decrease in the numbers of unemployed. The high level of unemployment is the greatest economic and social threat the nation currently faces and high energy costs will only perpetuate the problem. It is time for Democrats and Republicans to step up and start doing something real and effective about a problem that has dire consequences for the U.S. and the world.

Crude Dynamics - Oil Prices Begin an Overdue Correction

            Crude oil prices seem to be correcting from inflated highs as oil has dropped over $4.00 dollars a barrel today and have settled under $100. Thankfully the laws of supply and demand have finally gained some traction restoring a little order to the volatile oil prices of Q1 and Q2 2011. If these reductions hold the price of gasoline should decline by June and the financial burden placed on American motorists should be eased a bit helping the economy and discretionary income levels. 

Many have blamed speculation by investment banks for the recent volatility and ultimately for artificially inflating the price of oil. Others theorists have indicated that the recent spike is just part of a longer trend upwards which can’t be avoided as we begin to approach peak oil production across the world.  Both send ominous messages to the American consumer and the truth is that both factors are at work here in one degree or the other. But one of the two, speculatory inflation has the more sinister undertone of greed and profiteering in a time when our economy can least afford it.

             

             So what did it really take to drive down the price of crude and does this indicate that speculation was the culprit behind oil and gas prices?

            Well over the past two weeks we have seen:

• A 25% increase in the margin requirement on oil by the CME. Last week the CME raised margin requirements for silver and that commodity has lost about $20 per ounce over the last week.

• EIA reports that have indicated a steady increase in crude oil stocks (3.8 mbbl over the past week alone and 7.8 mbbl for the year) as well as a steady hold in gasoline consumption by American motorists despite the start of the summer driving season.

• A weakening of the Euro against the Dollar amid inflation problems in various E.U. nations and continued financial problems with Greece, Portugal and Spain.

• A cooling of the Chinese economy where inflationary control measures have tightened up money.

• An increase in unemployment filings indicating a slowing of the recovery and ultimately less commuters on the road.

The only mitigating factor in all of this is flooding around the Mississippi delta that may interrupt refinery operations in those areas.

Ironically any one of these events would have been enough in the past to drop oil prices slightly and the combination should be enough to drive the price back to 2010 levels.  However we still have seen only a $15 drop in crude per barrel which hasn’t translated into any real reductions at the pump. In Q2 of 2010 the price of gasoline was 2.81 per gallon while gasoline consumption was at 9.201 mbbl/d. In Q2 2011 gas prices are at 3.85 per gallon while consumption sits at 9.219 mbbl/d.

This seems to indicate that while Supply and Demand dynamics are taking effect speculation and fear of peak oil are still keeping the price artificially high. In the eyes of many recent efforts to rein speculation don’t seem to have gone far enough and the government should further regulate the oil futures market.

       With supplies of crude remaining steady and gasoline consumption flat lined we should be poised for a further drop in the price of oil and ultimately gasoline at the pump. However it is clear now that speculation is still keeping the price higher than it should be. After all it only took a war in Libya (Only about 2% of Libyan oil reaches U.S. shores) to drive the price up $40.00 per barrel why shouldn’t the 5 factors above drive the price back down?

Conspiracy Theories

            It seems to me that Americans love a good conspiracy even when there is no call for one.

The web is abuzz with questions surrounding the White House’s refusal to release pictures of a very dead Osama Bin Laden. Some Americans have concluded that it is just another indicator that Osama Bin Laden really isn’t dead and our government must be lying to the public. After all we did show pictures of the very dead Uday and Qusay Hussein not to mention Saddam himself and they weren’t nearly as hated as Osama Bin Laden.

So why not show pictures of Bin Laden with one to the head? Conspiracy theorists will tell you it has got to be because U.S. commandos really didn’t kill him Sunday night.

What I can’t seem to get from the theorists is a straight and logical answer as to why the government would fake Osama Bin Laden’s death?

The most popular answer for the time being is, “…to help President Obama get reelected.” Of course this begs the question why now and not right before the election when it would probably do the most good. With the current state of gas prices, unemployment and the deficit any good propaganda Osama’s death generates for the Obama campaign will most assuredly be drowned out by election time under a sea of economic reality.

Additionally it seems to me that a living Bin Laden would most likely want to come out and show that he is still alive to really stick it to America. Nothing as of yet but to believe the theorists it should be coming.

While the “Osama isn’t dead” silliness is gaining some velocity on the web the possibility of a very real conspiracy is playing itself out at the State Department between the U.S. and Pakistan.

There will be some hard questions asked of Pakistan and its intelligence service as we begin to analyze how our partner in the War on Terror and beneficiary of billions of dollars in aid managed to allow the most wanted man in the world to live 40 miles outside the capital and a stone’s throw from an army base without anyone noticing. Pakistan has been calling for a halt to U.S. Predator drone strikes and incursions into their country but events with Bin Laden seem to make acquiescing to these demands counter-intuitive. This all adds up to the very real possibility of a deterioration of our relationship with Pakistan and an added complication for our war in Afghanistan.

Ohh well, maybe when Osama comes out of hiding he and the Easter Bunny can tell us how they pulled it off.

Come and Get It? It Didn't Work for the Last Guy...

            Apparently Gov. Christie is planning on challenging the Federal Government in court if it persists with its demand to be repaid 271 million dollars loaned to New Jersey for the building of the scrapped ARC tunnel. Governor Christie remarked today at a press conference, “I ain’t paying it” and “…they’re going to have to come and get it.” 

An attack from SEAL Team 6 on his Mendham home not withstanding it appears the Governor has forgotten that Transportation Secretary LaHood has already indicated he will just withhold Federal Transportation funding from the State. This fact was reiterated again today and it could be that the Gov. is in court from the more precarious position of being owed money rather than the advantageous position of owing.

            From my vantage point the table is being set now for a financial perfect storm in New Jersey as events seem to be lining up against the Governor and the State. With 1.7 billion up in the air as the Supreme Court decides the legality of cuts to the educational system, 271 million owed to the Federal Government and huge holes in both the current fiscal budget, pension system and state highway funds the Governor may be forced to close critical state services or (gasp) beg Washington for a bailout.

            There also seems to be a rather alarming tendency by our Governor to just refuse to obey contracts or decisions that he hasn’t himself made. First he threatens to ignore the NJ State Supreme Court ruling and now tells the Obama administration to "come and get it". He keeps heading in this direction the State of New Jersey will have the credit rating and reputation of a recently paroled crack addict.

A Defiant Governor Christie

           Governor Christie has indicated in an interview that he would consider defying a ruling by the NJ State Supreme Court should it decide that his cuts to school funding during 2010 and 2011 school years were unconstitutional.

            The New Jersey Constitution requires under Article VIII Section IV, “1.  The Legislature shall provide for the maintenance and support of a thorough and efficient system of free public schools for the instruction of all the children in the State between the ages of five and eighteen years.” There are many advocates that indicate his drastic reduction in school funding is denying students this guarantee especially in poorer areas where state funding is critical. Amongst these advocates is Paul Tractenberg, founder of the Education Law Center, which brought the lawsuit.

            It goes without saying that while a ruling against the constitutionality of the Christie school cuts would be a windfall victory for Christie’s opponents, including the NJEA whom the governor has been at war with since his election, it will leave both the state (financially) and the governor (politically) in a very precarious position.

The question that immediately comes to mind when contemplating this ruling is with a 10 billion dollar budget deficit where is Governor Christie going to come up with the money? Christie has indicated that a variety of drastic cuts to hospitals and townships would be in order but in light of recent events one shouldn’t rule out a continued attack on state public worker pay and benefits.

More disturbing is the indication from the Governor that he may just ignore the Supreme Court’s ruling placing the state in a Constitutional crisis. 

Should the Governor choose to flagrantly deny the Supreme Court’s ruling it will only show him to be a petty tyrant and not the elected leader of a democracy. 

            The checks and balances of our democracy are critical to its continued existence and one of the only things that separate us from an autocratic dictatorship. Even indicating that refusal to obey the court’s decision is a possibility leads me to believe that the Governor is behaving like a spoiled child whose parents just told him he had to give back the toy he stole and not an intelligent elected official of a representative democracy.           

http://www.nj.com/news/index.ssf/2011/04/if_nj_supreme_court_orders_sch.html

http://www.njleg.state.nj.us/lawsconstitution/constitution.asp