Bank of England has admitted interest rate cuts don't cure inflation: gang8

Dear Gang

Honest, Guv, we didn't do nuffin'

The original binding force of Gang8 in 1998 onwards was our near-unanimous agreement that raising interest rates to lower inflation is mistaken : the economic equivalent of trying to extinguish a fire by pouring oil on it. We circulated numerous arguments showing that raising interest rates just makes inflation worse.

At the time, this was all utter economic heresy but we didn't mind about that. A little over a year earlier, after all, the Bank of England had been set free to ‘control inflation' and the only weapon it was given to do so was jiggling the base interest rate up and down.

Now times have moved on. Just yesterday the Governor of the Bank of England admitted, for the first time, that the interest rate "weapon" is quite useless to control whatever inflation is going to be thrust upon us by the combined effects of high oil and other fuel prices, higher commodity prices and China's waning ability to export deflation with its cheap manufactured goods.

Instead, the new British policy will be to let inflation run its natural course and the Governor promises instead to write a succession of open letters to the Chancellor of the Exchequer to explain this new economic policy of sitting on his hands.

Which, I suspect, leaves economic orthodoxy about the setting of interest rates and inflation rates in tatters. One way to cut costs would be to disband the Bank of England's Monetary Policy Committee and leave interest rates around 3 per cent, where they should have been all along - just like Keynes left Bank Rate unchanged for over a decade.

Latest score:

Heretics 1, Central bankers nil.

Chris Meakin

Stiglitz: Stagflation Cometh

http://www.project- syndicate. org/commentary/ stiglitz95

Stagflation Cometh

by Joseph E. Stiglitz

New York – The world economy has had several good years. Global growth has been strong, and the divide between the developing and developed world has narrowed, with India and China leading the way, experiencing GDP growth of 11.1% and 9.7% in 2006 and 11.5% and 8.9% in 2007, respectively. Even Africa has been doing well, with growth in excess of 5% in 2006 and 2007.

But the good times may be ending. There have been worries for years about the global imbalances caused by America’s huge overseas borrowing. America, in turn, said that the world should be thankful: by living beyond its means, it helped keep the global economy going, especially given high savings rates in Asia, which accumulated hundreds of billions of dollars in reserves. But it was always recognized that America’s growth under President George W. Bush was not sustainable. Now the day of reckoning looms.

America’s ill-conceived war in Iraq helped fuel a quadrupling of oil prices since 2003. In the 1970’s, oil shocks led to inflation in some countries, and to recession elsewhere, as governments raised interest rates to combat rising prices. And some economies faced the worst of both worlds: stagflation.

Until now, three critical factors helped the world weather soaring oil prices. First, China, with its enormous productivity increases – based on resting on high levels of investment, including investments in education and technology ­– exported its deflation. Second, the United States took advantage of this by lowering interest rates to unprecedented levels, inducing a housing bubble, with mortgages available to anyone not on a life-support system. Finally, workers all over the world took it on the chin, accepting lower real wages and a smaller share of GDP.

That game is up. China is now facing inflationary pressures. What’s more, if the US convinces China to let its currency appreciate, the cost of living in the US and elsewhere will rise. And, with the rise of biofuels, the food and energy markets have become integrated. Combined with increasing demand from those with higher incomes and lower supplies due to weather-related problems associated with climate change, this means high food prices – a lethal threat to developing countries.

Prospects for America’s consumption binge continuing are also bleak. Even if the US Federal Reserve continues to lower interest rates, lenders will not rush to make more bad mortgages. With house prices declining, fewer Americans will be willing and able to continue their profligacy.

The Bush administration is hoping, somehow, to forestall a wave of foreclosures – thereby passing the economy’s problems on to the next president, just as it is doing with the Iraq quagmire. Its chances of succeeding are slim. For America today, the real question is only whether there will be a short, sharp downturn, or a more prolonged, but shallower, slowdown.

Moreover, America has been exporting its problems abroad, not just by selling toxic mortgages and bad financial practices, but through the ever-weakening dollar, in part a result of flawed macro- and micro-policies. Europe, for instance, will find it increasingly difficult to export. And, in a world economy that had rested on the foundations of a “strong dollar,” the consequent financial market instability will be costly for all.

At the same time, there has been a massive global redistribution of income from oil importers to oil exporters – a disproportionate number of which are undemocratic states – and from workers everywhere to the very rich. It is not clear whether workers will continue to accept declines in their living standards in the name of an unbalanced globalization whose promises seem ever more elusive. In America, one can feel the backlash mounting.

For those who think that a well-managed globalization has the potential to benefit both developed and developing countries, and who believe in global social justice and the importance of democracy (and the vibrant middle class that supports it), all of this is bad news. Economic adjustments of this magnitude are always painful, but the economic pain is greater today because the winners are less prone to spend.

Indeed, the flip side of “a world awash with liquidity” is a world facing depressed aggregate demand. For the past seven years, America’s unbridled spending filled the gap. Now both US household and government spending is likely to be curbed, as both parties’ presidential candidates promise a return to fiscal responsibility. After seven years in which America has seen its national debt rise from $5.6 trillion to $9 trillion, this should be welcome news – but the timing couldn’t be worse.

There is one positive note in this dismal picture: the sources of global growth today are more diverse than they were a decade ago. The real engines of global growth in recent years have been developing countries.

Nevertheless, slower growth – or possibly a recession – in the world’s largest economy inevitably has global consequences. There will be a global slowdown. If monetary authorities respond appropriately to growing inflationary pressure – recognizing that much of it is imported, and not a result of excess domestic demand – we may be able to manage our way through it. But if they raise interest rates relentlessly to meet inflation targets, we should prepare for the worst: another episode of stagflation.

If central banks go down this path, they will no doubt eventually succeed in wringing inflation out of the system. But the cost – in lost jobs, lost wages, and lost homes – will be enormous.

Joseph Stiglitz is a Nobel laureate in economics. His latest book is Making Globalization Work.

Copyright: Project Syndicate, 2008.
www.project- syndicate. org

Some people will swallow any cod's swallop as we say

Here's the friggnin proof.

Man, I think Hank Paulson is SO low.

Too bad those of us who KNOW don't get the ink.

Bill Bonner, The Daily Reckoning, UPDATE

More of the usual very interesting stuff .. even IF you dont' invest, and I surely don't. My family lost all their dough in 1929 during the crash; I was thus instructed:

NEVER INVEST! NEVER!

Sure can't lose "your shirt" following that advice.

Only you'll never wear anything more than a "Republican cloth coat" if you do follow that as yer family motto. And a damned good thing I discovered the down parka, isn't it??

Still observing the commentaries and actions of those who wear fur coats is always highly instructive. And I do do that!! (remember, this guy thinks royalty is a Good Thing! more stable. The truth of the matter is England was FORCED to pick between empire and democracy - and although it HAS royals rather than an imperium can be said to have more feedback from citizens, actually, than the United States .. but I digress!! What else is new?)

I did a piece herein, about liars, derivatives, hedge funds, MORALITY that somehow got lost in the shuffle and "only" played in the Hongkong papers, showing how many LIES were afloat as to their efficacy and SAFETY sometime back. The folks at home just thought I was joshing, but I really did watch their rise knowing that "the chickens would come home to roost" and I outlined the reasons that that was - and to whom to point the finger(s) of blame. This was my first public outcry against Hank Paulson, the PPT, with a real nod to George H.W. BuZh who really let the market FRY, seems like ON PURPOSE. But those are the games of the WEALTHY - let's put our ear to the wall as the rich speak, but with Good Wisdom ..

Ssshh ...!

<<:>> $ <<:>> $ <<:>>

We still think the tide has turned. Stocks are going down...along with housing .

But gold is over $800 again...while the dollar is mostly steady.

What’s ahead for the dollar? As we said in The Economist , its long-term value is zero. But the fact that The Economist picked up our quip makes us worry. Bashing the dollar has gone prime time. So, the buck could actually be over-sold – at least in the short run. Will it rise against the euro? The last report we got, put Euroland cash growing at more than 12% per year. Not exactly Zimbabwe, but still three to four times faster than GDP. It’s not just the dollar that will go to zero. All paper currencies will get there. Which one takes the lead now? We have no opinion.

And who says you can’t make money in hedge funds ? Hedge funds must be one of the dumbest asset classes ever invented. It is like getting someone to put coins in a slot machine and then splitting your winnings with him. Over time, you will lose all your money...but occasionally, you can get lucky. Look at this...and pity the poor dopes on the other side:

“A Californian hedge fund has made more than 1,000 per cent return this year by betting against U.S. subprime home loans, making it one of the world’s best-performing funds of all time,” reports the Financial Times .

“Lahde Capital, set up in Santa Monica last year by Andrew Lahde, last week passed the 1,000 per cent mark, after fees, following the latest leg of the credit market turmoil. The fall in the value of subprime-linked securities has boosted a group of funds which spotted the problems in advance.

“The decision to use derivatives to short, or bet against, low-quality U.S. home loans taken by a select group of hedge funds last year appears to have become the most profitable single trade of all time, making well over $20bn in total so far this year.

“However, Mr Lahde, whose fund is one of the smallest specialists shorting subprime, has now begun to return money to investors, telling them in a letter: ‘The risk/return characteristics are far less attractive than in the past.’

“In his letter, Mr Lahde said he expected the collapse in value of subprime mortgage-linked securities to be repeated for bonds backed by commercial property loans in a deep recession - which he also predicts.

“‘Our entire banking system is a complete disaster,’ he wrote. ‘In my opinion, nearly every major bank would be insolvent if they marked their assets to market.’ He also said he would be putting some of his own profits into gold and other precious metals.”

Hmmm...looks like a little bit of luck – and a good understanding of the actual trends at play here. Our colleagues, Mish and Brian, over at The Survival Report , have profited from the volatility in the mortgage markets – specifically from Countrywide’s wild ride.

In fact, subscribers to The Survival Report were perfectly positioned to profit when Countrywide Financial Corp. hit the skids. For the full report, including the triple-edged “housing hedge” offered therein, read on here .

*** “The economy has slowed down...but just a little,”

explained a colleague in Johannesburg. “

Here in South Africa, we’ve had very good growth over the last few years. Now, GDP growth is down to about 4%...but it’s still good.

“And there’s a lot of activity. People are starting new businesses. People are making money. In fact, there’s probably too much activity. Traffic is terrible in downtown Johannesburg. So many people are getting cars. And we don’t really have the infrastructure to keep up with them. What’s more, we’re running out of energy. They cut the power off a couple of hours at a time. There just isn’t enough capacity...and it takes a long time to add new generators. So, they try to apportion what power there is. We have to run a generator whenever the power goes out.

“Yes, there are a lot of problems here. But the story is basically good. People who never had any money before are entering the modern economy. South Africa is booming. And I think it will continue to boom until 2010. We have the World Cup coming. They’re going to spend a fortune on transportation and infrastructure to get ready for them...unless the money is stolen.

“Tomorrow, the central bank is expected to put up its key lending rate to 14.5%. But just look at the headline: ‘Consumer confidence on the rebound.’ They’re putting up rates to stop inflation...but inflation isn’t that bad...just about 6%.”

Until tomorrow,

Bill Bonner
The Daily Reckoning

How do You Spell Stagflation? by John Mauldin
This week we look at inflation. Is it just over 2%, giving the Fed room to cut rates, or will it be closer to 4% by the next FOMC meeting, making a rate cut problematic? How do they get those numbers? When and how can two opposite things be true at the same time? The answer depends on how many dimensions you are living in when you are asking the question. The Fed is going to be faced with a very difficult decision at its next meeting, and there results of there deliberations will be felt by you. But first, an observation about a milestone passed last week. I started this letter 7 years ago with about 2,000 names and it has grown to where it is sent to more than 1,000,000 of my closest friends each week. For the last year, this letter has been translated each week into Chinese and posted on a Chinese version of Thoughts from the Frontline web site by my Chinese assistant Coryne Wei. This last week we passed 1,000 subscribers that get the Chinese version. I know that is small, but it is a beginning. It will be interesting to see how it grows over the years. If you would like to get this letter in Chinese, you can go to www.frontlinethoughts.cn and subscribe. How do You Spell Stagflation? I wrote this summer that it was likely that we would see inflation as reported in the Consumer Price Index rise dramatically in the fourth quarter. This is due to the very low year over year comparison numbers of last years fourth quarter. We got the CPI numbers yesterday, and we did indeed see a rather uncomfortable rise in inflation, just as I predicted. "Headline" inflation is at 3.5% over the last 12 months, well above anybody's comfort level, and "core" inflation (inflation without food and energy in the numbers) is at 2.1% over the same period. It is likely to look worse in the coming months, at least in the statistics. To see why, let's go the table below from the Bureau of Labor Statistics who creates the CPI. The monthly numbers are the index for inflation. Since the base is from 1982-84, we can see that sometime last year prices doubled over the last 25 years. But it certainly feels like it has been more. We will look at how those numbers are created in a minute, and whether we can attach much credulity to them. Now, here is what to notice in the table. The number for December is the same as the number for October. Since the beginning of this year we have seen a steady rise almost every month. If you assume inflation is running at 2%, this would mean that the November number would yield a 3.8% inflation rate and would be closer yet to 4% for December. If you extrapolate the inflation of the past two months for the next two months, that would take inflation slightly over 4% as we go into the next two Fed meetings. Yes, we all know the Fed prefers to look at core inflation, but at some point you do have to pay attention to the headline number. Today, in a speech in New York, Federal Reserve Governor Randall Kroszner said policy makers probably won't need to reduce interest rates further to help the economy weather a "rough patch" in the coming year. "The current stance of monetary policy should help the economy get through the rough patch during the next year, with growth then likely to return to its longer-run sustainable rate," Kroszner said. Data consistent with such growth "would not, by themselves, suggest to me that the current stance of monetary policy is inappropriate." The risks are roughly balanced between inflation and growth in his opinion. However, futures prices still suggest that the market expects an 84% chance of a rate cut at the December 11 meeting. Cooking the Inflation Books Just for the record, I want to state that I know as does nearly everyone else who pays attention to the CPI statistics that they are bogus. They do not reflect the real world that you and I, gentle reader, live in. So, while it may look like I take them at face value, I do so only because the Fed pays attention to the number, (nod, nod, wink, wink) and makes policy based upon it. So, let's look at how the calculation of the CPI has been politicized and how much of a difference it makes, and then go on to the expectation for statistical inflation in the near future. John Williams writes an excellent monthly letter on all types of government statistics called the Shadow Government Statistics at www.shadowstats.com. One of the things he points out that during the Clinton administration, the way the BLS calculates inflation was changed. He calculates his own inflation number using the old pre-Clinton inflation model. Using that methodology suggests that inflation is at 7%. And if you use other methods, inflation might even be substantially higher. Look at the chart below. Since the CPI is used to calculate the increase in Social Security payments and a host of other items, calculating inflation is important. I the early 1990s the arguments in the press was that inflation was over-stated. Michael Boskin, chief economist in the first Bush administration and Alan Greenspan were among the chief proponents for a new methodology of accounting for inflation. Quoting Williams: "Up until the Boskin/Greenspan agendum surfaced, the CPI was measured using the costs of a fixed basket of goods, a fairly simple and straightforward concept. The identical basket of goods would be priced at prevailing market costs for each period, and the period-to-period change in the cost of that market basket represented the rate of inflation in terms of maintaining a constant standard of living. "The Boskin/Greenspan argument was that when steak got too expensive, the consumer would substitute hamburger for the steak, and that the inflation measure should reflect the costs tied to buying hamburger versus steak, instead of steak versus steak. Of course, replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that. "The Boskin/Greenspan concept violated the intent and common usage of the inflation index. The CPI was considered sacrosanct within the Department of Labor, given the number of contractual relationships that were anchored to it. The CPI was one number that never was to be revised, given its widespread usage. "Shortly after Clinton took control of the White House, however, attitudes changed. The BLS initially did not institute a new CPI measurement using a variable-basket of goods that allowed substitution of hamburger for steak, but rather tried to approximate the effect by changing the weighting of goods in the CPI fixed basket. Over a period of several years, straight arithmetic weighting of the CPI components was shifted to a geometric weighting. The Boskin/Greenspan benefit of a geometric weighting was that it automatically gave a lower weighting to CPI components that were rising in price, and a higher weighting to those items dropping in price. "Once the system had been shifted fully to geometric weighting, the net effect was to reduce reported CPI on an annual, or year-over-year basis, by 2.7% from what it would have been based on the traditional weighting methodology. The results have been dramatic. The compounding effect since the early-1990s has reduced annual cost of living adjustments in social security by more than a third." Then to confuse the process even more, the BLS uses something called hedonics, from the root word hedonism. Essentially, the adjust the price of an item based on the "pleasure" or increased value you get. Thus, they don't price automobiles based on the sticker price, but on what you get for your money. If the manufacturers load in more items like new electronics or anti-locking brakes that were not standard the year before that means you are getting more value for your dollar, so therefore the price in terms of inflation goes down even though you may be paying the same or even more to get out of the car show room. The same is true for computers. We clearly get more power every year, so for the BLS the price of computers are going down, although it seems to me that the price I pay for a top of the line computer is about the same as it was five or ten years ago. If the government mandates an additive to gasoline that costs 10 cents more, that is not included in the inflation numbers, because we get a new, improved gasoline that pollutes less. Supposedly the pleasure of breathing cleaner air reduces the costs to our pocket book, or something like that. My health insurance costs have tripled over the last ten years, and I know that is the experience of many of my readers. Yet, the BLS has medical costs rising by less than 50% for the last ten years. Their data suggest the cost of housing has risen by about 30% over the last ten years. Again, that is not the experience of many of my readers. Social Security expenses are $657 billion per year. If Williams is right (and I think he is) that under the old methodology that expenses would have risen by a third, then that means we are spending $200 billion a year less. Add $200 billion to the deficit. And then watch politicians panic. I am not one to suggest conspiracy, but if the CPI reflected the real world, the US government would be spending far more money on Social Security and a host of other pension programs. The crisis we will be experiencing in about 8 years would have already hit us. Thus, there was an incentive for leaders to find economists who could argue for new, more "progressive" methods for calculating inflation. Notice that this was done by the BLS without any protest from Congress. None of this was done behind closed doors. The BLS, to its credit, is extremely open about how it calculates CPI, and you can get an enormous amount of detail on their web site about prices of things like tomatoes in very part of the country going back for decades. But the way we calculate the CPI is not going to change. No administration will want to go back and add in an extra 4-5% a year to Social Security and other government pension programs. So, let's return to the prospects for a rise in the CPI in the near future, which will have policy implications for the Fed. Gaming the Producer Price Index On Wednesday, we got the Producer Price Index. After the above notes on the CPI, it will probably not come as a surprise that there may be some problems with the PPI. The PPI rather oddly has the price of energy going down in October. PPI is important, as it is in indication of the trend of inflation in consumer prices in the future. As friend Bill King notes: "Since June, BLS has energy prices declining in all three PPI stages: finished, intermediate and crude. For June finished energy goods the index is 160.9, for October 159.5; the intermediate prices are 179.9 vs. 178; for crude it's 238 vs. 232.9. BLS has energy prices DOWN 3.64% since July!! [emphasis NOT mine, btw.] "Oil has rallied from ~$75 to the mid-90s since July 9. Over the same period, gasoline has rallied from $1.95 to $2.35; heating oil has rallied from $2.15 to $2.55; natural gas has fallen from $8.50 to $8.25." That means that inflation in the PPI numbers may be less than the table below, which is bad enough. Notice the increase in the change of year over year inflation in the index over the last 8 months. Another table shows "core" PPI, without energy and food, and you find that core PPI is flat. Again, we are seeing almost all of the real inflation in food and energy. But with a falling dollar, do we expect food and energy prices in the US to fall as well, since much of the price of food and energy is determined on international markets? Consumer Spending is Up, but then Again, It May Be Down Headline consumer spending came in up 5.2% year over year, which suggest a very respectable growing economy. But retail sales were only up 0.2% in October, which is below inflation. In other words, retail sales fell in October in real terms. But digging deeper into the numbers, we find a problem. Remember food and energy. As Greg Weldon points out, it is unlikely that US consumers bought 16% more gasoline than they did last year. The increase in spending for gasoline was all related to price. Ditto for food. John Williams says the same analysts who want to use core inflation should also use core retail sales. And if you take out food and energy from retail sales, you find consumer spending to be flat in October. There were multiple categories like home furniture, music, electronic games, etc that were in outright declines. Most interestingly, online sales actually dropped last month. Annual sales growth dropped to its lowest number in years. FedEx warned today that its earnings would be down due to fewer shipments and higher energy costs. The number of containers coming into the US is down. Retailers are expecting a very modest Christmas season. So, we come to the question: Is the economy slowing and thus the Fed will cut, or is inflation rising which will force the Fed to sit tight? A Two Dimensional Problem I recently spent some time with the very brilliant Columbia Professor Graciella Chichilnisky (the economist whose work created the carbon credit markets, among other things). We got to talking about the problems the Fed is facing, and she gave me a very interesting insight from a paper she had written a few years back. I am going to try and re-create it, though I am sure I will take some of the potency away in trying to put it in my simple terms. Assume that you have an individual living in a two dimensional world. For them there is only length and width, but no height. Then let's draw a line between two exactly opposite points above and below that two dimensional world and connect them with a line. At the precise point where the lines meet in the two dimensional world, to the individual in that world, it appears that both points are exactly the same. Two things which would clearly be opposite to anyone living in a three dimensional world would be equal in a two dimensional world. The Fed faces a problem something like that. They are living in a two dimensional world, working with two dimensional tools (they can cut rates or raise them) but the problems they face are multi-dimensional. If they cut rates, the dollar will fall and import prices rise, and it will also likely have negative effects on food and energy prices. If they do not cut rates, the markets will simply throw up as it will interpret that as a Fed which is not concerned about a slowing economy. Not cutting rates risks an economy that could easily slip into recession due to a growing risk of a credit crisis turning into a credit crunch. Usually, that means that inflation will fall. Usually, but not always. The Fed is faced with a problem I predicted four years ago in this letter and in Bull's Eye Investing, as the Fed dramatically eased monetary conditions in an effort to fight deflation. In a word, stagflation. That terrible moment in time when an economy slows (is stagnant) yet inflation is high, limiting the monetary authority's ability to act. With a clearly slowing economy, a credit crisis, and rising inflation, they have no good and clear choices. Whatever they do is likely to create problems in a multi-dimensional real world. I still think they cut, as core inflation is still close to their comfort zone. But if core inflation starts to rise, they will have to act. Or at least should. Saudi Justice I usually avoid controversial matters, other than economics and finance, but I came across a story which I think deserves attention. It seems that a 19 year old young lady in Saudi Arabia was gang-raped by six armed men. They got between one and five years in prison. Because she was in a car with a man who was not related to her, she was given a sentence of 90 lashes. Because she appealed and a higher court ordered another trial, the court then more than doubled the sentence to 200 lashes. "A court source told the English-language Arab News that the judges had decided to punish the woman further for 'her attempt to aggravate and influence the judiciary through the media.'" Her lawyer had his credentials removed for defending her. This is simply barbaric. It is an affront to any civilized thoughtful person. Where are the protests? Are we to believe that the Saudi royalty condones such acts? http://www.breitbart.com/article.php?id=071115145104.rykb7bub&show_article=1Ifanyone I hope that other writers will use this in their letters. New York, Toronto, Europe and Thanksgiving This week I had to take a quick one day trip to Toronto. Changing my ticket ended up costing me six times the original round trip ticket. To add insult to injury, I got in a taxi at the Toronto Airport. It used to cost about $50 Canadian dollars to get a ride to downtown. The price has risen to $60 and then throw in a $10 tip. A few years ago, this would cost me about US$35. Today it was $70. I offered the taxi driver 3 twenty dollars bills and a tip, but he pointed out that the exchange rate made my US$60 only worth about Canadian $55. Sigh. I am going to have to go to New York again in a few weeks to attend the Minyanville BBQ picnic and charity fundraiser. South African business partner Prieur du Plessis will be there, but I am going because his wife Isabel has demanded my attendance. And a European trip late in January is shaping up.
John Mauldin Frontlinethoughts.com