InvestorCentric

Asset diversification in reducing the risk of your portfolio

2014-07-07T11:45:00.001-07:00

The Top 10 alternative investments to consider for your IRA

Provided by iDIRECT

Until recently, many average investors limited themselves to investing in stocks and bonds within their retirement plans. Only high-net worth clients were taking advantage of investing in alternative assets within their retirement plans, specifically Individual Retirement Accounts (IRAs). The most famous example of alternative assets used to fund an IRA to exceptional effect is the 2012 Presidential candidate, Mitt Romney. He invested in private shares and the investments of his company, Bain Capital. As of 2010, the value of his IRA was between $20 million and $100 million.

Now, the average investor, seeking diversification in their portfolios, are turning to alternative assets to stocks and bonds. The following is a list of the 10 investment strategies bringing wealth to people using self-directed IRAs to invest in alternative assets.

Residential Properties
Commercial Rentals
Vacation Rentals
Raw Land Development
Private Lending
Precious Metals
Tax Liens/Deeds
Start-Up Businesses
Private Placements
Oil and Gas Royalties

Other popular investments include crowd funding, private equity investments, private mortgages, or promissory notes, as the options are really limitless. The IRS code doesn't say what you can invest in, but instead identifies which investments are not permitted. These prohibited investments include life insurance contracts and collectibles (such as works of art, rugs, jewelry, etc) according to Internal Revenue Code Section 401 (IRC § 408(a) (3)).

This article discusses in more detail, five popular non-traditional assets that the IRS permits in an IRA.

Real Estate:

The most popular non-traditional asset is real estate. Investors can invest in rentals properties where the rent grows tax free, or flip houses, purchase foreclosures, or purchase foreign property.

Precious Metals:

Since the 2008 Great Recession, precious metals, particularly gold, are becoming an alternative to conventional assets, such as stacks and bonds, to protect the value of their investments against a weakening dollar, geopolitical uncertainty, inflation and deflation, and as part of a diversified portfolio. The IRS has limited the type of precious metals allowed in an IRA. For example, only gold that has a .995% purity are allowed in an IRA.

Promissory Notes:

A promissory note is a written agreement between you and another party to loan a specific sum to be paid back at a specific date in the future. There are two types of promissory note: secured and unsecured. A secured note is note backed by collateral, and an unsecured note is not backed by collateral and the interest rates on these loans tend to be higher than secured loans.

Tax Liens:

Yes, tax liens are allowable assets within an IRA. A tax lien is a legal claim by a government entity against a non-compliant taxpayer's assets. When you purchase a tax lien, you are purchasing the right to collect the outstanding taxes. Once the tax lien has been purchased, you only have to wait until the delinquent taxes are paid. If these taxes go unpaid for three years, you will have the right to take possession of the property through foreclosure.

Venture Capital:

Venture capital is money provided by an investor(s) to start-up firms and small businesses with perceived long-term growth potential. Most venture capitalists invest for long-term capital growth, not for income. Therefore, a Roth IRA is suitable for this type of asset because capital gains are tax-free. You must be aware that the IRS prohibits "self-dealings," that is, using their IRA assets to benefit them or their family before you retire.

How to invest in alternative investments within an IRA

Not all IRA providers have the administration to deal with alternative assets. Only specialist custodians have the expertise to establish self-directed IRAs. Alternatively, if you wish direct control of your assets, you can use the IRA LLC model offered by an IRA facilitator who can generally set up an IRA LLC cheaper than a lawyer or accountant who may be familiar with the structure.

Since the stock market fluctuations of 2008- 2010, many investors have lost confidence in the stock market and wish to diversify part of their portfolios away from stocks. Not only do they want asset diversification within their portfolios, they also want to invest in assets they know. Investing alternative assets within an IRA is not a new investment strategy, as Mitt Romney has proved. In fact, the legal basis of self-direct investing passed in 1974. It has only been recently, however, that this investment strategy has become mainstream.

For more information on self-directed IRA LLCs, visit www.idirectlaw.com

Ukraine Turmoil Boosting Gold Prices, But Should We Buy?

2014-05-13T06:56:00.001-07:00

Gold prices are a funny thing, the more turmoil and uncertainty there is in the world, the higher the value goes. Gold is considered a 'safe haven' investment. For thousands of years, and from civilization to civilization, gold has retained monetary value. So if you're worried about the zombie apocalypse, or Russia taking over the world - gold should be your investment of choice (or guns I suppose). That being said, as a US based investor, should I be running to buy gold because of something going on thousands of miles away? Can I make some money investing in gold right now?

At the end of the day, we're investors, right? If there is an opportunity to make a good return, then it's at least worth looking at.

So, is there truly an opportunity to make money investing in Gold today? I'm not convinced, but let's do some quick internet searches and see what some of the 'Gold Investment Experts' have to say.

When you start doing research about why you should buy gold, interestingly enough, most of the commentary happens to be from companies that sell gold - that, and the doomsday publications that try to get you to pay for their investment newsletters. Typically that's not a good sign, but I carried on, and this is what I found:

Forbes - 3 Reasons To Buy Gold Now
Money Morning - 1,600 Reasons To Buy Gold Now (Just in case 3 wasn't enough)
WSJ - The Case For Gold

Okay, now for the other side of the argument:

DoughRoller - 6 Reasons Gold Is A Terrible Investment
MarketWatch - Why Buffett Thinks Investing In Gold Is Stupid
USA Today - Gold: The Investment Dog That's Not Hunting

Personally I'm still not convinced gold is the investment for me. The fact that it doesn't generate any income, has limited commercial use beyond jewelry, and is really expensive, are all pretty big turn offs. At the same time, I feel like I should have at least a small portion of my portfolio invested in precious metals and other commodities. After looking at some other precious metals options, I did come across one that seemed pretty intriguing.

If I'm going to start buying precious metals, that precious metal is going to be silver. Silver might not get as big a boost in value as gold when the world goes crazy, but it does get some. The kicker for me, though, is that silver has so many more practical applications. Gold is basically used for jewelry, and that's it. Silver is still used in jewelry, but it has a ton of other applications as well.

Silver is used in all sorts of manufacturing, including computers, smartphones and televisions, among many others. In addition to being one of the best conductors of electricity, silver also has antibiotic properties that make it vital to the medical industry. The more I learn about silver, the more interested I become. Gold might not be for me, but if I decide to diversify some of my portfolio into precious metals, it's good to know there is another option out there.

This guest post was contributed by Sam Jenkins.

This guest article does not represent the views or opinions of NuWire Investor, or any of its subsidiaries.

What's Going To Happen To Freddie And Fannie? What Does It Mean For Mortgage Rates?

2014-03-22T11:58:00.002-07:00

Yesterday RealtyTrac published a good article talking about the debate currently going on in Washington D.C. about Freddie Mac and Fannie Mae. There are several moving parts in this whole ordeal that investors should be aware of. Rather than trying to regurgitate those for you here, we suggest you read the article from RealtyTrac.

It's mind boggling how much money the government is pulling in from Frannie and Freddie now. However, at the same time it feels like we've been down this road before. Mortgage rates can't stay this low forever, can they? Everything is rosy now, but what happens if this new real estate bubble that seems to be forming pops? As soon as mortgage rates start to go back to a normal range, what's going to happen to the housing market?

Housing values are being inflated thanks to historically low interest rates. When that 3.75% 30 year fix mortgage goes to 5%, all the sudden instead of being able to afford a $300,000 house, that same homebuyer will only be able to afford a $260,000 home. The housing market simply won't be able sustain current values once this rate increase happens. Then, just like we saw before, the snow ball effect will come into play and things will get exponentially worse.

If the government shuts down Freddie and Fannie, you can be that rates are going to increase a lot faster than they would otherwise. At the same time, though, this current model is not sustainable either, at some point it is going to crash, and the government is going to be on the hook. I suppose at least this time around the government gets to participate in the upside. Too bad they don't do a a better job of managing the profits.

What Is The Correlation Between Oil Prices And Inflation?

2014-02-08T10:11:00.000-08:00

Many investors believe that the movement in oil prices can give them advance signals into how inflation will change in the future. Is there any truth to this, though? Well, Mehmet Pasaogullari and Patricia Waiwood from the Federal Reserve of Cleveland recently ran the numbers to help answer that question once and for all. Here is the summary of their findings, which you can read more about here:

Some analysts pay particular attention to oil prices, thinking they might give an advance signal of changes in inflation. However, using a variety of statistical tests, we find that adding oil prices does little to improve forecasts of CPI inflation. Our results suggest that higher oil prices today do not necessarily signal higher CPI inflation next year, although they do help to explain short-term movements in the CPI.

Being able to predict changes in inflation could make investors a lot of money, but apparently using oil prices to foretell those changes isn't the golden goose some people thought.

Fed Prints More Money

2013-11-07T07:01:00.000-08:00

A quick look at the Federal Reserve’s balance sheet in terms of assets has led some economist’s to wonder what the Fed is planning to do, while others say there is no plan at all. The lion’s share of assets are tied up in U.S. Treasury securities and mortgage-backed securities, which doesn’t seem like a problem when inflation rates are kept in check as they are now, but when considering the financial turmoil experienced in the last seven years there are some who believe that more quantitative easing may lead to rude awaking in this fragile financial ecosystem. For more on this continue reading the following article from Tim Iacono.

After catching up a bit on all the commentary related to the Federal Reserve’s ongoing money printing effort such as this item from yesterday and today’s offering from Jim Jubak at MSN Money where it was concluded that “The Fed has no endgame“, refreshing the simplified graphic of the central bank’s balance sheet below seemed like a good idea, particularly since they are rapidly closing in on the $4 trillion mark.

Of course, there is a growing consensus that this is all benign (or at least irrelevant as long as stock prices are rising) and that argument is lent some credence by the low rates of inflation for consumer prices reported in the West (inflation in developing nations is an entirely different matter). Somehow, it seems the quadrupling of the Fed’s balance sheet (and then some) will prove to be anything but benign.

This article was republished with permission from Tim Iacono.

Breaking Down Transactional Funding For Real Estate Investors

2013-09-21T14:46:00.002-07:00

Investing in real estate offers a lot of opportunity for financial growth. Flipping properties, the process of buying at low cost, quickly renovating and selling at much higher cost, is an excellent way to make fast profits. However, you may not always have funds readily available to make purchases, and you don’t want to be in constant loan debt. That’s when transactional funding can help.

What is transactional funding?

Transactional funding refers to a transaction-based short term loan that you use to purchase property that you will turn around and sell. The proceeds of that sale are then used to pay back the loan, allowing you to avoid a long-term debt. The loan is transaction-based because the purchase by you, called the A-B side of the transaction, as well as your subsequent sale to another buyer, the B-C side of the transaction, must already be arranged in order to obtain this type of loan.

What are the advantages?

You can enjoy several advantages from a transactional funding loan versus a regular hard money loan, including:

No credit checks
No proof of income required
No money down
Loan covers closing costs
Lower loan costs

Credit checks and income verification are not required because the loan is based solely on having a buyer ready to purchase the property from you as soon as you have closed on it. Having the B-C end of the transaction lined up for as soon as you complete the A-B part of the transaction significantly reduces the risk to lenders, allowing for more favorable loan terms than other types of real estate loans could offer. That, plus the fact that the loan is short term, allows transactional funding loans to be less expensive than regular loans. With no money down required, you can capitalize on lucrative properties for which you may not have the funds to purchase up front.

What types of transactions can be funded?

While the loan cannot be used for mobile homes or non-real estate transactions such as vehicle purchases, you can take advantage of the loan for most real estate properties. Qualifying properties include commercial real estate, for sale by owner homes, bank owned/foreclosed homes and apartment buildings. As a savvy investor, you can make an excellent profit purchasing properties at a discount, such as bank foreclosed homes, flipping and selling them at a higher profit margin.

This article was originally published on realestatemoney.com.

Retirement Options Dwindle

2013-03-28T10:08:00.002-07:00

The recession, the housing crisis, increasing taxes and a turbulent employment landscape has made it nearly impossible for many people nearing retirement to do so comfortably, according to a recent study. The report from the Employee Benefit Research Institute shows that employer-provided retirement plans and other savings vehicles will not be adequate to fund retirement even for those who have saved, and that the news is even worse in the black community. Moreover, it appears government is looking to cut retirement plan benefits further, which means the problem is only going to get worse. For more on this continue reading the following article from Economist’s View.

The "news isn’t good" about the shift from defined-benefit to defined-contribution pension plans:

Declining Wealth Brings a Rising Retirement Risk, by Bruce Bartlett, Commentary, NY Times: ...[In] defined-benefit ... pension plans..., workers are promised a specific income at retirement, which the employer provides. The employer bears all the risk of market fluctuations. Under a defined contribution scheme, such as a 401(k) plan, the worker and the employer jointly contribute to a tax-deductible and tax-deferred account from which the worker will finance retirement. ...

Now the first generation of workers who have virtually all their pension saving in defined-contribution plans is nearing retirement, and the news isn’t good. According to a March 19 report from the Employee Benefit Research Institute, only about half of workers nearing retirement have confidence that they have enough money saved for an adequate retirement.

Not surprisingly, retirement saving has taken a back seat to more pressing concerns – coping with unemployment, maintaining standards of living during an era of slow wage growth, putting children through increasingly expensive colleges and so on. ...

This problem is much more severe for black Americans. ... The wealth gap isn’t only racial, it’s generational...

What’s really depressing about these studies is the lack of solutions and the likelihood that the problem will only get worse.

Republicans in Congress have pressed for years to convert Social Security, a classic defined-benefit pension, into a defined contribution plan, and also to convert Medicare into a voucher program. These changes would shift even more of the financial risk in retirement onto families that have yet to adapt to fundamental changes in employer pensions and the economy over the last 30 years. The future doesn’t look pretty.

Members of Congress appear to be eager to cut retirement benefits even further to show they can make the hard choices (and the president seems to be on board). They should raise the payroll cap instead, but the "hard choice" that would hit the people who can afford it isn't under consideration. It's not hard to imagine why.

This blog post was republished with permission from The Economist's View.

US Housing Starts Improve

2013-03-21T07:26:00.000-07:00

The latest Commerce Department reports shows that U.S. housing starts are on the upswing, although experts note that basing predictions on data so early in the year may lead to drawing erroneous conclusions. Even so, single-family home construction starts have climbed more than 27% when compared to the same time last year, which competes with levels not seen since 2008. Permit issuance is also up and is tracking closely to starts, although both numbers still remain at one-third the amount seen prior to the start of the U.S. recession in 2006. For more on this continue reading the following article from Iacono Research.

The Commerce Department reported(.pdf) that housing starts rose 0.8 percent in February to an annual rate of 917,000 units and permits for new construction, a key leading indicator for the home building industry, jumped 4.6 percent to a rate of 946,000, the highest level since June 2008.
From year ago levels, housing starts are up 27.7 percent and permit issuance is 33.8 percent higher.

Starts for single-family homes rose 0.5 percent to a rate of 618,000 units, also the highest level since 2008, accounting for about two-thirds of the overall total, however, home building remains about one-third below the pre-housing bubble pace of about 1.5 million units per year.

It is once again worth pointing out that not too much should be inferred from housing data at this time of the year due to dramatically lower activity in most of the country during the winter months and the outsized impact of seasonal adjustments. Nonetheless, this offers more evidence of ongoing improvement in the housing market as builders ramp up their plans for new construction in the months ahead.

This blog post was republished with permission from Tim Iacono.

Experts Say Gold Down, Not Out

2013-03-07T07:35:00.000-08:00

Precious metals prices have been slowly trailing off for months, which is a sharp turn for what was once a bull market for gold and silver. Investment firms are downgrading their forecasts and the Federal Reserve is printing money left and right, and the combined effect has been hard on investor sentiment. One expert believes the metals can rally, however, especially if a trend toward inflation becomes evident. Actual inflation is admittedly unlikely in the near term, but if the money printing appears that it may cause inflation it could be followed by renewed interest in gold and silver. For more on this continue reading the following article from Iacano Research.

It’s no secret that precious metals have disappointed many investors in recent months after prices failed to move higher following the announcement of more money printing by the Federal Reserve late last year.

So far in 2013, gold and silver have moved steadily lower based in large part on the idea that despite the central bank creating $85 billion per month in new money, inflation is not a near-term threat (and maybe not even a long-term concern).

In recent weeks, investment banks have been falling over themselves in an attempt to downgrade their precious metals price forecasts sooner and farther than their competitors and this has helped to sour sentiment. Also, record outflows from gold ETFs such as the SPDR Gold Shares (GLD) have added to the selling pressure.

Based on what you might read in the mainstream financial media these days, you may as well stick a fork in the secular gold bull market because it’s all but done (and maybe silver too), but there’s a very good argument to be made for why that is not so.

In short, now that the latest round of Fed money printing is causing the monetary base to grow, higher inflation is likely to follow. Then, perhaps suddenly, investors and traders will flock back to precious metals.

Allow me to explain.

[To continue reading this article, please visit Seeking Alpha.]

Economist Skewers Fed’s Expert Outlook

2013-02-21T10:13:00.000-08:00

Tim Iacono takes note of Neil Irwin’s recent critique in the Washington Post of U.S. government economists and their prognostications for the last few years, arguing that they basically don’t know what they’re talking about and may even be guessing. He points to their GDP growth predictions for 2011 and 2012 and how they were both similarly inflated. He then points to the outlook for 2013 and suggests the rhetoric could have been cut and pasted from previous years, leaving some to expect the worst when it comes to this year’s economic performance. For more on this continue reading the following article from Iacono Research.

A look at the abysmal track record in recent years in forecasting economic growth by the nation’s top government economists as related by Neil Irwin in this Washington Post story. Also see the related graphic that depicts how poor a job the economy has been doing in getting back to its “potential” growth.

They say that the essence of futility is to keep doing the same thing while expecting a different result. But is that what key government forecasters are doing in determining their outlook for the economy?

Throughout the halting economic recovery that began in 2009, the formal economic projections released by the Congressional Budget Office, White House Council of Economic Advisers, and Federal Reserve have displayed quite a consistent pattern: This year may be one of sluggish growth, they acknowledge. But stronger growth, of perhaps 3.5 percent, is just around the corner, and will arrive next year.

Consider, for example, the Fed’s projections in November of 2009. Sure, growth would be slow in 2010, they held. But 2011 growth, they expected, would be 3.4 to 4.5 percent, and 2012 would 3.5 to 4.8 percent growth. The actual levels of growth were 2 percent in 2011 and 1.5 percent in 2012.

What’s amazing is that the Fed’s newest projections, released in December of 2012, look like they could have been copy and pasted from 2009, just with the years changed: They forecast sluggish growth in 2013, 2.3 to 3 percent, followed by a pickup to 3 to 3.5 percent in 2014 and 3 to 3.7 percent in 2015.

Increasingly, it appears that this is one of those times when “it really is different” in that we’re not about to return to “trend growth” and for good reason – it was artificial, based on a reckless expansion of credit.

Then again, another reckless expansion of credit might just do the trick.

This blog post was republished with permission from Tim Iacono.

Per Capital Government Spending Chat Draws Fire

2013-02-14T07:23:00.002-08:00

Economist Mark Thoma, spurred by commentary from Paul Krugman regarding President Obama’s real government spending, created a graph to compare Obama’s annualized growth in real per capita government spending with that of the last six presidencies. The result, which reflects the Obama Administration’s comparatively low spending, created a small storm among partisan and non-partisan economists regarding the breakdown of the numbers and Obama’s perceived austerity in the face of economic crises. For more on this continue reading the following article from Economist’s View.

Via email:

Seeing the Krugman commentary comparing real government spending under Obama and Reagan made me curious about what it looks like if you express it in per capita terms? In particular, how does the Obama period compare with other presidencies in terms of penury/austerity versus spendthriftness?

To compare presidencies, I did the calculation two ways. One starts in the quarter before the president was elected (e.g., 2008Q4), the other starts in the first quarter of the presidency (e.g., 2009Q1). (The ARRA probably had some effect in Q1, but most of the change was simply economic conditions that the incoming president had nothing to do with, so I think I prefer the Q1 to Q1 method). Ranking since Johnson (starting in 1968), and using the first-quarter comparisons, and calculating growth under Obama through 2011Q4, Clinton is the most austere, followed by Obama. The most spendthrift are (1) Nixon-Ford, (2) Reagan, and (3) Bush II. The figure is pasted below:

This blog post was republished with permission from Economist's View.

CBO Budget Outlook Review

2013-02-07T10:10:00.000-08:00

The Congressional Budget Office (CBO) has released its budget forecast for the next ten years and the prognostication is not tethered to reality, according to one critic. Tim Iacono notes that CBO analysts believe the big picture translates into fewer policy decisions in the future to the high level of federal debt, but he argues the real trouble is that an increase in GDP and lower unemployment will have to rely on the inflation of an asset bubble that will make the last 15 years look small by comparison. For more on this continue reading the following article from Iacono Research.

The first page of The Budget and Economic Outlook: Fiscal Years 2013 to 2023 from the Congressional Budget Office contains the following summary charts that tell you quite a bit about how this group sees our future.

What’s interesting about the first chart is that it’s being interpreted in two very distinct ways. Some say, “See there! The debt is stabilizing. There’s no need to do anything more.” while others (including the CBO) conclude, “This high level of debt will restrict policy choices during any future crisis”.

A small minority (including myself) think that the lower two graphics are the more important parts of this report since, for all the wrangling over taxes, spending, and debt that go into the numerator of the debt-to-GDP equation, the denominator gets far too little attention.

There is clearly no recognition that the U.S. has come to the end of a multi-decade credit boom that has goosed both economic growth and employment. Moreover, about the only way we’ll return to “trend growth” and a 5 percent jobless rate by 2017 is to inflate an even bigger (and, ultimately, more destructive) asset bubble than what we’ve seen over the last 15 years and this is clearly not factored into any of this forecast.

This article was republished with permission from Tim Iacono.

Government Spending, GDP Drops

2013-01-31T09:14:00.000-08:00

A 22% decline in government defense spending is being blamed for a 0.1% drop in the country’s GDP in the fourth quarter of 2012, while consumer spending grew at a 2.2% annual rate in the same period. Investment was also up in the fourth quarter, particularly in the housing sector, and overall performance is trending toward an overall GDP gain of as much as 3% over the coming year. Inflation, which was once thought to be a significant threat, actually moved lower and experts note that statistics point to there being no real impact from “fiscal cliff” concerns during the quarter. For more on this continue reading the following article from Economist’s View.

Dean Baker on todays' news the GDP shrank in the 4th quarer of last year:

Falling Government Spending and Inventories Push Growth Negative in Quarter, by Dean Baker: A sharp drop in government spending, heavily concentrated in defense, coupled with a decline in inventories caused GDP to shrink at a 0.1 percent rate in the 4th quarter. Government spending fell at a 6.6 percent annual rate, driven by a 22.2 percent decline in defense spending, subtracting 1.33 percentage points from the growth rate in the quarter. A 40.3 drop in the rate of inventory accumulation reduced growth by another 1.27 percentage points. Without these factors, GDP would have grown at a 2.5 percent annual rate in the quarter.

Pulling out these extraordinary factors, the GDP data were largely in line with prior quarters. Consumption grew at a 2.2 percent annual rate, driven mostly by 13.9 percent growth in durable goods purchases, primarily cars. This number was inflated due to the effects of Sandy, which destroyed many cars, forcing people to buy new ones. Growth in this category will be substantially weaker and possibly negative in the next quarter. On the other side, housing and utilities subtracted 0.47 percentage points from growth in the quarter. This is likely a global warming effect with warmer than normal weather leading to less use of heating in the quarter. (There was a comparable falloff in the 4th quarter of 2011 when we also had unusually warm weather.)

One especially noteworthy item is the continuing slow pace in the growth of spending on health care services, which accounts for almost three quarters of all health care spending. Nominal spending grew at a just a 2.3 percent annual rate in the quarter. Over the last year, nominal spending is up by just 1.8 percent, far less than the rate of growth of GDP, and well below the projections from the Congressional Budget Office (CBO). It seems increasingly likely that we are on a slower health care cost trajectory. The deficit picture will look very different when CBO incorporates this slower growth trend into its projections.

Investment rebounded from a weak third quarter in which non-residential investment actually shrank. This quarter it added 0.83 percentage points to growth, with investment in equipment and software growing at a 12.4 percent rate. Housing continued to be a big positive in the quarter, adding 0.36 percentage points to growth.

Net exports were a modest drag on growth. While both exports and imports fell in the quarter, the 5.7 percent drop in exports more than offset the positive impact of a 3.2 percent decline in imports. The state and local sector government sector shrank at a 0.7 percent annual rate, knocking 0.08 percentage points off growth. Non-defense federal spending rose at a 1.4 percent annual rate.

The inflation hawks will be disappointed in this report with the overall price index rising at just a 0.6 percent annual rate. The core CPE rose at a 0.9 percent rate. Insofar as there is any trend in these data it is toward lower inflation.

One interesting item in the report was a $122.90 jump (85.2 percent at an annual rate) in dividend payouts. This was the result of companies deciding to pay out dividends to shareholders in 2012 when a lower tax rate was in effect on high-income taxpayers.

There is little evidence in this report to believe that the economy will diverge sharply from a 2.5- 3.0 percent growth path, except for the impact of the deficit reductions that Congress is considering or already put in place. Higher tax collections from the ending of the payroll tax holiday are likely to knock around 0.5 percentage points from growth. The sequester, or whatever cuts are put in place in lieu of the sequester, are likely to have an even larger impact on growth beginning in the second quarter.

One item worth noting is the GDP report provides zero evidence that "fiscal cliff" concerns had any impact on growth in the quarter. Consumer durable purchases and investment in equipment and software were the two strongest components of GDP. If worries over the fiscal cliff were supposed to cause people to put off purchases, consumers and businesses apparently did not get the memo.

Nevertheless, with the slow recovery of output and employment all is not well no matter how we spin the numbers. We need more spending on infrastructure to help with the recovery.

This article was republished with permission from The Economist's View.

US Fiscal Policy Fine, Experts Say

2013-01-24T05:35:00.002-08:00

Partisan economics is nothing new and every administration faces complaints from opponents that it’s either spending too much or too little, depending on the desired media outcome. In 2013, many economists agree that the U.S. fiscal policy is finally shaping up and that it’s a lack of employment and rising health care costs that are the real issue. Deficit hawks complain that liberals in big government are spending too much, but a comparison in real dollars shows the Bush years increasing the most of the last three administrations. Some even argue that President Obama is cutting too much and that a recovery requires more investment. For more on this continue reading the following article from Economist’s View.

Peter Orszag:

Healthcare is America’s real problem, by Peter Orszag, Commentary, FT: Healthcare costs are the core long-term fiscal challenge facing the US... This is why the recent deceleration of these costs is so encouraging...

The good news is that recent developments in health costs are better than many appreciate. Cost growth has slowed dramatically...

Last year, the Congressional Budget Office estimated that the gap between revenue and expenditure in the next 75 years would amount to 8.7 per cent of GDP. Since then, enacted revenue increases and an improved underlying budget outlook have reduced the gap to perhaps 7.5 per cent.

Achieving the lower health-cost growth would knock another 2.5 per cent of GDP off, bringing the long-term fiscal hole down to 5 per cent of GDP – a greater impact than any policy change currently being debated in Washington. ...

Martin Wolf:

America’s fiscal policy is not in crisis: ...The federal government is not on the verge of bankruptcy. If anything, the tightening has been too much and too fast. The fiscal position is also not the most urgent economic challenge. It is far more important to promote recovery. The challenges in the longer term are to raise revenue while curbing the cost of health. Meanwhile, people, just calm down.

By the way, where were the deficit hawks during the Bush years? Here's what Martin Wolf means by "If anything, the tightening has been too much and too fast":

[via Kevin Drum]

The deficit hawks don't want you to know this, but our biggest problem right now is not the deficit, it's jobs.
This blog post was republished with permission from Economist's View.

European Commission Addresses Economy

2013-01-17T06:48:00.002-08:00

The European Commission’s 2012 report on employment and social development has impressed economists as an accurate summary of what has gone wrong with the Eurozone economy in the last year and what will become of it this year, although it’s still questionable whether the insights gleaned from the report will be used to help make the situation better. Economist Jonathon Portes’ interpretation of the report is that a lack of aggregate demand as the result of macroeconomic policy mismanagement as the source of current woes, and that the poorest countries are getting worse, even if other areas are recovering. For more on this continue reading the following article from Economist’s View.

Jonathan Portes (he also provides discussion of each of these points):

European labor markets: six key lessons from the Commission report, by Jonathan Portes: I haven't always been complimentary about the European Commission - either its economic analysis or its policy advice. So it's nice to be able to be wholeheartedly positive about the excellent report "Employment and Social Developments in Europe 2012"...

The report is really worth reading. But it's close to 500 pages, and the main messages deserve as wide an audience as possible, so I thought I'd try to highlight them with some commentary. To my mind, the key ones are the following:

1. Economic weakness in Europe, and the consequent rise in unemployment, are mostly to do with a lack of aggregate demand, which in turn is the result of mistaken macroeconomic policies - especially aggressive fiscal consolidation...

2. Although financial markets may have stabilized - who knows for how long - things are getting worse, not better, in the real economy of the crisis countries...

3. Countries with more generous welfare states, but also more flexible labor markets, have fared best...

4. Following on from this, structural reforms in labor markets are required in many countries - but they need to be based on evidence! Segmented labor markets are a problem and raise youth unemployment...

..and even in recession, minimum wages at a sensible level do more good than harm. ...

5. Where they were allowed to operate, the "automatic stabilizers" worked...(in both macroeconomic and social terms)...

...while where they were overridden, in the pursuit of "self-defeating austerity", things have got worse...

6. Latvia, Ireland (and even Estonia) may look like "success stories" to some in the Commission, and perhaps to the financial markets (at present) but the reality in terms of jobs and incomes is rather different. ...

Too bad fiscal policymakers didn't do their homework and learn these lessons about austerity, social insurance, automatic stabilizers, and so on before putting harmful or ineffective policy in place (or failing to implement policy when action is called for, e.g. to reduce unemployment). Wish I thought they were doing their homework now.

This blog post was republished with permission from Economist's View.

Fiscal Cliff Deal Inadequate

2013-01-04T08:51:00.000-08:00

The simple fact is that the deal that was reached to avoid the so-called “fiscal cliff” is nothing more than a postponement of the real negotiation, which will have to bear results if the country is to avoid across-the-board spending cuts in the form of sequestration. The March deadline looms larger than that of the cliff and Republicans and Democrats have already drawn lines in the sand. The GOP will refuse to vote for an increase in the debt ceiling unless Democrats agree to cuts to entitlement programs, and the entire drama will be played out again, although this time experts feel there is less chance of positive resolution. For more on this continue reading the following article from Iacono Research.

My takeaways from the recent fiscal cliff deal.

First, thank God people will now stop talking about “going over the fiscal cliff”. Fed Chief Ben Bernanke has done many terrible things at the central bank, but coining the phrase “fiscal cliff” was clearly one of the worst.

Second, anyone thinking that this is somehow the end of the story when it comes to the U.S. budget difficulties should be immediately absolved of that notion since, before you know it, there will be another catchy phrase to describe what is about to happen over the next two months.

Based on what I’ve been reading, it will be termed an “abyss” of some sort – the debt ceiling abyss, the sequestration abyss, the government funding abyss, or, my personal favorite appearing in the title above, sans the “abyss” moniker. This Bloomberg report summarizes what lies ahead:

If anything, the U.S. faces an even more ominous deadline in a few months. The debt ceiling was hit as of New Year’s Eve. The U.S. Treasury will dip into its tool bag to keep the country’s borrowing ability going, but that will last only about two months. Also in early March, the sequestration — $110 billion in across-the-board spending cuts, half in defense and half in domestic programs – springs back, unless Congress finds a way to offset it with other spending cuts. Weeks later, the law that keeps the government funded expires. It all means that, in late February and early March, Congress will face a sequestration, a government default and a government shutdown. Republicans say they’ll use the leverage created by the debt ceiling to force Obama to accept spending cuts, particularly in entitlement programs. Obama resisted that notion on Dec. 31, saying he wants more tax increases and won’t accept Republican plans to “shove” spending cuts past him. “If they think that’s going to be the formula for how we solve this thing, then they’ve got another thing coming,” he said.

Per this story at The Hill, the duo of Simpson and Bowles probably best characterized the result as follows:

“We have all known for over a year that this fiscal cliff was coming. In fact Washington politicians set it up to force themselves to seriously deal with our Nation’s long term fiscal problems,” Simpson and Bowles added. “Yet even after taking the Country to the brink of economic disaster, Washington still could not forge a common sense bipartisan consensus on a plan that stabilizes the debt.”

What does this mean for financial markets in general and precious metals in particular? These thoughts from the Bank of Nova Scotia appearing in this Globe & Mail report today provide a good summary:

The U.S. budget agreement is likely to prove [U.S. dollar] negative in the medium term as it averts the fiscal cliff today but fails to provide a credible medium-term fiscal plan and instead forces major issues, like the debt ceiling and $110-billion in spending cuts, out to March 1, and highlights how challenged the U.S. political system has become. In addition, it potentially lays the foundation for a rating agency downgrade.

Anyone who grew tired and angry about the fiscal cliff debate over the last couple months should enjoy the current reprieve while they can because it will be just days (maybe only hours) before we start hearing about the much more difficult (and dangerous) debate that lies ahead.

This post was republished with permission from Tim Iacono.

Policymakers’ Risk Fiscal Cliff

2012-12-13T06:54:00.000-08:00

The debt ceiling, which refers to how much the U.S. federal government may go into debt, has become a bargaining chip in the final round of debate over how to avoid the fiscal cliff. Republicans have promised not to agree to raise it until President Obama offers deeper spending cuts. In a recent message to Congress, the president told Republicans that there would be no negotiating for raising it later if they allow negotiations about the fiscal cliff to fail now, and many economists feel taking the debt ceiling off the table is a smart move for the White House, if only to ensure that if a recession is to result that it comes now instead of at the end of Obama’s second term. For more on this continue reading the following article from Economist’s View.

One more from Tim Duy:

The Debt-Ceiling Gamble, by Tim Duy: Ezra Klein reports that the White House is drawing a line in the sand on the debt-ceiling, and they really, really mean it:

The Obama administration is utterly steadfast on this point: They will not suffer a repeat of 2011, when they conducted negotiations over whether the United States should default. If Republicans go over the cliff and try to open up talks for raising the debt ceiling, the White House will not hold a meeting, they will not return a phone call, they will not look at the e-mails.

The Administration is looking to take the debt ceiling off the table forever. This is good policy; that Congress should be able to pass laws authorizing spending but not authorizing the required debt is beyond ridiculous. Also ridiculous - and irresponsible - is the willingness of the Republicans to use the debt ceiling to hold the economy hostage. Ending this travesty should be a priority for the White House.
Klein adds that the White House is ready for the fight now while their strength is up:

Boehner and the Republicans don’t want to give up the leverage of the debt ceiling forever, or for 10 years, or even, as John Engler, head of the Business Roundtable and a former Republican governor suggested, for five years. But the White House isn’t very interested in compromising on this issue, as they figure that if there needs to be a final showdown over the debt ceiling, it’s better to do it now, when they’re at peak strength, then delay it till 2014 or 2015, when their own vantage might have ebbed.

I would add another advantage. Better - from a political point of view - to have a recession at the beginning of President Obama's second term that can be blamed entirely on the Republicans. A recession in the first half of 2013 means that, most likely, the Democratic presidential nominee can run on the back of an improving economy by 2016. Alternatively, they run the risk that this recovery, anemic as it is, gets long in the tooth by 2016. Even worse would be that they agree to let the Republicans once again hold the economy hostage two years from now. Politically, if I had to pick between a recession now or closer to the next election, I would pick now.

This blog post was republished with permission from Economist's View.

Fed Talks Thresholds, Operation Twist

2012-12-06T06:45:00.000-08:00

Economists are predicting what the Federal Reserve will tackle at is next Open Market Committee (FOMC) meeting and the two first guesses include policy guideline discussions and a look at Operation Twist. On the first topic, many Fed execs want to make clear that unemployment cannot be the only beacon for determining threshold levels. Regarding Operation Twist, or how the Fed will hand large-scale asset purchases, many economists feel that the move to an outright asset purchase program signifies an easing of current policy, although a final determination must involve the outcome of the fiscal cliff. For more on this continue reading the following article from Economist’s View.

Tim Duy:

Monetary Policy to Become Easier Next Week?, by Tim Duy: There are two important issues to be discussed at next week's FOMC meeting. One is the issue of specific thresholds as future policy guides. The second is the replacement for Operation Twist. Clearly, support is building for specific thresholds, and I believe policymakers will work out the details within the next meeting or two. Also, I think the general sense is that the Fed will continue to purchase long-term Treasuries after Operation Twist is complete. But will they continue to purchase the full $45 billion a month? That seems like it should be an open question, but it looks like momentum is building in that direction.
St. Louis Federal Reserve President James Bullard offered his thoughts on both these topics yesterday. On the first point, he offers support for replacing the forward guidance with a set of thresholds. I don't find this to be surprising. Bullard has never been a huge fan of the time commitment implied in the current statement. Not only does it send a pessimistic signal about the economy, in theory it should respond more flexibly to evolving economic events. But in practice, the Fed is only willing to alter the date in the event of a substantial shift in the economic outlook.
Bullard cites the 6.5/2.5 unemployment/inflation thresholds recently described by Chicago Federal Reserve President Charles Evans. I am not sure that Bullard specifically endorses these figures, but he may sense the political wind is blowing in that direction. He nicely describes six challenges to a threshold regime:

The Fed needs to make clear that in the long-run the Fed cannot target unemployment.

He believes the threshold should be on actual outcomes, not forecasts.

The Fed needs to communicate that policy is about more than just two variables. For example, he suggests the possibility of raising interest rates to limit asset price bubbles.

Unemployment is not the only measure of the labor market. The Fed takes a broader view of labor markets into consideration.

Unemployment can remain high, such as in Europe (I think this is really just a restatement of point one).

Beware that thresholds will be viewed as triggers, which they are not.

I think these are valid concerns the Fed needs to address as the communication strategy evolves. Bullard then shifts gears to Operation Twist. Currently, large scale asset purchases come in two flavors. One is $40 billion a month in outright mortgage purchases (QE3), the other a monthly swap of $45 billion in short-term Treasuries for an equal amount of long-term Treasuries (Operation Twist). The former is open-ended, the latter concludes this month. Should it be fully converted to an outright asset purchase program? San Francisco Federal Reserve President John Williams gave his opinion last month:

Meeting with reporters following a speech at the University of San Francisco, MNI asked Williams whether he thinks the FOMC should replace the Operation Twist Treasury purchases dollar for dollar upon their expiration Dec. 31. He answered strongly in the affirmative.
"My view is based on the expectation that we won't see substantial improvement in the labor market" for awhile, Williams said, adding that therefore "my view is that we should continue with purchases of long-term Treasuries after December into next year."
Williams said he favors "just purely buying long-term Treasuries at the rate we're buying."
Asked to clarify, Williams said he favors buying MBS and Treasuries "at the same rate we're doing now" -- $85 billion per month.

Boston Federal Reserve President Eric Rosengren agreed yesterday. Operation Twist changes the composition of the balance sheet, not its size. If the Fed converts to an outright asset purchase program, they will more than double the pace of net purchases. In my opinion, this appears to be a substantial easing of policy. Bullard feels similarly:

...on balance I think it is reasonable to think that an outright purchase program has more impact on inflation and inflation expectations than a twist program....
...Replacing the expiring twist program one-for-one with outright purchases of longer-dated Treasuries is likely more dovish than current policy.

I think that is correct; the conversion of Operation Twist should be considered a more aggressive policy. Yet inflation expectations (with the usual caveats about TIPS based expectations) continue to wane:

Perhaps financial market participants do not expect the Fed to commit to the full $85 billion in purchases. But this does not seem to be the case. There has been more than enough Fedspeak to suggest that additional easing is coming. Which leads me again to wonder if monetary policy is now at full throttle? $40, $50, or $85 billion a month. Does it make a difference? Or is the expectation of additional easing simply offsetting expectations of tighter fiscal policy?

Bottom Line: The Fed is gearing up to convert Operation Twist to an outright purchase program. A complete conversion should be considered a more aggressive policy stance. If the Fed wants to hold policy constant, then we would expect a less than one-for-one conversion. There are reasons to expect the Fed would go the full monty. Notably, the fiscal cliff drama already appears to be affecting the economy, even though it is more risk than reality. But why are inflation expectations sliding? And what does that imply about the effectiveness of additional easing at this juncture? Important but as of yet unanswered questions.

This post was republished with permission from The Economist's View.

Early Holiday Spending Stats Lower

2012-11-29T06:39:00.002-08:00

Perhaps bolstered by signs of an economic recovery, analysts who had been expecting strong pre-holiday consumer sales figures were disappointed to see a sharp decline in spending this year. Gallup reports that Black Friday numbers were considered fair, but that subsequent spending has not been as strong as the last three years based on American self-reported spending. Experts say the decreased sales could be linked to Cyber Monday deals and trepidation about the looming fiscal cliff and what it may means for the housing market as well as the broader economy. For more on this continue reading the following article from Iacono Research.

The folks at Gallup threw a cat amongst the pigeons today with the release of this survey on how many American consumers opened their wallets last week and how big their December credit card bills might be. (Does anyone pay cash anymore?) Though spending was higher this year during the week before Thanksgiving, self-reported spending during the holiday week fell from averages of $79 per day in 2010 and $83 per day last year to just $67 per day last week, not even besting the level of $69 in 2009.

Such issues as Thanksgiving coming relatively early this year and growing “Cyber-Monday” sales could be behind the sharp decline and, of course, there’s lots of time between now and Christmas for Americans to spend more, though, with the “fiscal cliff” looming and financial markets shaky, that is by no means assured.

This blog post was republished with permission from Iacono Research.

Sandy Stalls Sales

2012-11-15T08:19:00.000-08:00

The Commerce Department reported the first drop in consumer sales since June 2012 and analysts are blaming ‘Superstorm’ Sandy on the slip. The storm arrived at typically busy consumer period and auto sales in particular felt the brunt of the blow. Even so, insurance companies note that nearly 250,000 vehicles have been claimed as total losses, which automakers hope will boost sales in the near future. Meanwhile, REtail sales remained flat while gas station sales enjoyed a marginal 1.4% despite falling prices. For more on this continue reading the following article from Iacono Research.

The Commerce Department reported(.pdf) that U.S. retail sales fell last month for the first time since June, down 0.3 percent in October following an upwardly revised gain of 1.3 percent in September, as Superstorm Sandy was cited as having both a positive and negative impact on the data.

Though the effects of the storm could not be isolated, it is believed that its arrival during the busy month-end period depressed East Coast auto sales leading to a decline of 1.5 percent in October auto sales nationally, this following a jump of 1.7 percent the month prior. Automakers said they expected lost sales to quickly be made up as nearly a quarter million vehicles were totaled during the storm.

Excluding autos, retail sales were flat last month after a gain of 1.2 percent in September as 8 of the 13 categories declined, paced by a surprising drop of 1.9 percent at home improvement stores. In the wake of the iPhone 5 launch the month before, electronic store sales fell 1.0 percent and nonstore retailers saw a drop of 1.8 percent. Gasoline station sales rose 1.4 percent even though pump prices fell throughout the month and food & beverage sales rose 0.8 percent, leading the advancing categories.

This blog post was republished with permission from Tim Iacono.

Expert Ponders Fed Policies, Plans

2012-11-01T06:09:00.000-07:00

Economist Tim Duy would like to reconcile the Federal Reserve’s near-term and long-term plans for fiscal responsibility with the real state of the U.S. economy but has trouble connecting the dots. He believes its attempt to hit very specific targets will likely fail to due to its inability to communicate needs across channels as well as a seeming disconnect with the fact that the economy is not in a mode of full recovery. He argues that increased government spending may be able to break the cycle of stagnation that is being caused by restricting natural inflation, otherwise fiscal austerity and another recession may take root. For more on this continue reading the following article from Economist’s View.

Tim Duy:

On Coordinated Monetary and Fiscal Policy, by Tim Duy: Note: This began as an effort to tie together various themes in my writing. Unfortunately, short and succinct did not work. So I apologize in advance for the length of this post.

There are certainly trends in my writing. One is that the Federal Reserve spent much of this year behind the curve by failing to adapt their large scale asset purchase program or their communication strategy to the reality of a persistently weak economy. The Federal Reserve effectively dealt with that issue at the last FOMC meeting.

To be sure, I can quibble with some of the specifics, such as a lack of more explicit economic targets and a clear commitment to near term-irresponsibility by allowing inflation to rise above 2 percent when (or if) the economy gathers steam. On the first issue, I am coming around to the thinking that while explicit targets (other than inflation or nominal GDP) might sound good in theory, in practice trying to tie policy to a constellation of price and output targets risks becoming a communications nightmare. The Fed needs to tread very carefully on this point; it may be best for them to fall back on that old adage about pornography. We will know a "sufficient and sustainable" recovery when we see it.

The second issue, a promise to be irresponsible on inflation, remains unlikely as long as the Fed continues to stress it will take actions "in the context of price stability." I don't view a temporary increase in inflation as necessarily undermining neither the Fed's long-term inflation targets nor a nominal GDP target. And I think that the failure to make such a promise could very well disrupt a reversion of the economy to pre-recession trends. This I will discuss further later.

Another trend in my writing is that there needs to be some coordination between fiscal and monetary policy. Putting aside what I believe will be an aberration in the third quarter, authorities are already engaged in some degree of fiscal austerity:

and have effectively promised to do more. Should it even be reached, a compromise to the fiscal cliff will likely still be further austerity. I think that we should be wary about underestimating the impact of such austerity, especially as it is increasingly evident that multipliers are larger than expected at the zero bound. Fiscal austerity would likely be a key factor in maintaining the relatively tepid pace of the recovery into 2013. Moreover, fiscal austerity wastes the opportunity provided by a low interest rate environment. The Federal Reserve has already promised to buy a steady stream of assets from the financial markets. All Congress needs to do is sell debt into that stream. No explicit coordination necessary.

Another issue that I can't run away from is the potentially negative impacts of a sustained zero interest rate environment. It would be a mistake to believe that monetary policy does not have distributional impacts. Low interest rates obviously hurt savers:

Moreover, we should be concerned about distortions to the capital allocation process. Encouraging excessive risk taking now will come back to haunt us later. That said, it is necessary to balance such negative impacts against the positive impacts. Nor is it clear that the Federal Reserve is driving this train; the absence of an aggressive monetary policy might very well weaken the economy such that interest rates fall further. In any event, I am challenged to see how a different monetary policy would be effective; tightening policy at this juncture would likely be disastrous for the economy.

Finally, another issue to which I have already alluded is a belief that the US economy is on a suboptimal path:

This is obviously controversial. For example, St. Louis Federal Reserve President James Bullard has repeatedly said there is only one path, and we are on it. The appropriate monetary and fiscal reaction functions are obviously different in a such a world. In such a world monetary policy leads only to potentially greater inflation with little impact on growth.
Jumbled as it might seem due to the nature of blogging, somewhere in the background I have a framework that ties this altogether. And I was reminded by a colleague that I had seen that framework presented by another colleague, George Evans. The associated paper, "The Stagnation Regime of the New Keynesian Model and Recent US Policy" is here.
Evans begins with a New Keynesian in which expectations are formed by adaptive learning. An outcome of the model is that a sufficiently large negative shock can push the economy into a deflationary trap. Interestingly, agents learn their way into the trap by forming pessimistic expectations of future economic outcomes. My interpretation is that agents learn to live in what is often called the "new normal" and as a consequence make decisions that ensure the the new normal is a stable equilibrium.
The model is subsequently modified to account for nominal wage rigidities such that the low equilibrium trap, the stagnation regime, has an inflation floor. Another characteristic of the regime is low levels of output and consumption in which welfare is potentially much lower than the preferred equilibrium.
How can we break out of the stagnation regime? A temporary increase in government spending that is sufficiently large to allow a self-sustaining process to take over. The economy reaches an escape velocity such that agents learn there way allow a dynamic path to the preferred locally stable, higher equilibrium. At such a point, government spending can revert to normal without threatening a recession.
Monetary policy can also come into play, but Evans is less optimistic that the Federal Reserve is capable of breaking the US economy out of the trap. He notes that even promises of low rates forever may not be enough if the economy has suffered a sufficiently large negative shock. Evans adds that quantitative easing can support the economy via lowering long-term rates and stimulating demand, but also warns:

An additional problem, however, is that there are some distributional consequences that are not benign. Households that are savers, with a portfolio consisting primarily in safe assets like short maturity government bonds, have already been adversely affected by a monetary policy in which the nominal returns on these assets has been pushed down to near zero. A policy commitment at this juncture, which pairs an extended period of continued near zero interest rates with a commitment to use quantitative easing aggressively in order to increase inflation, has a downside of adversely affecting the wealth position of households who are savers aiming for a low risk portfolio.

There is a lot to digest in a short paper, but I encourage making the effort.
Thinking in terms of this model, it is immediately clear that one should be very concerned with impending fiscal austerity unless you believed the economy had already reached escape velocity (I don't). Moreover, you should be concerned about austerity even in context of the evolution of monetary policy into QE3 as it is not clear that the Fed can by itself push the economy to escape velocity. The Fed is literally stuck between a rock and a hard place, with the stimulative force of lower rates for borrowers traded off against lower income for savers, a point that Ed Harrison often makes. And the more we lean on monetary policy, the tighter that space gets. Yet we have little choice with a political environment that favors austerity over stimulus.
In addition, one should be concerned about the fragility of any recovery based upon a Fed-induced effort to achieve escape velocity. This is especially the case if the Fed has not promised (and whether such a promise is credible is another question) to be irresponsible in the transition to the higher equilibrium. Consider that the CBO projection for GDP growth is 4.8% in 2015. This, I suspect, is the kind of number needed to achieve escape velocity. But consider the Fed's reaction function in the face of such growth in the context of 1.) price stability and 2.) internal concerns about the ability to unwind quantitative easing. I think under those circumstance policymakers would error on the of tighter, faster rather than allowing a temporary acceleration of inflation.
The last paragraph brings up an interesting question. Even if the Fed promised to allow inflation to accelerate and did so, eventually they would tighten policy just the same. Which means the same recession, just a year later. 2015 or 2016. 2017 at the latest.
The problem is that the recovery is pretty much held together by debt refinancing, cheap mortgages and higher asset prices; by such measures, monetary policy has been successful! To be sure, there has been some debt reduction on the part of households:

But it is limited in comparison of the ability of households to utilize lower interest rates to reduce the cost of financing that debt:

I think in the near-term those who believe the monetary authority is the only answer will appear correct as the recovery progresses. Indeed, Annie Lowrey at the New York Times reports that household debt is now increasing for the first time since the Great Recession began. From a broad macroeconomic perspective, this is a near-term positive, and creates reason to believe that monetary policy will cushion the impacts of whatever flavor of the fiscal cliff we experience.

But I don't think this will be a stable long-term result. Obviously, I could be wrong, but it seems to me that we are using the same trick we have been using since the mid-1980's - lowering debt financing costs, thus allowing for a greater debt burden. This trick will continue to work as long as there is room to push interest rates further down. Now that we are at the zero bound in short-term rates and the Fed has been forced to move quite far out the yield curve to implement monetary policy, it is likely this is the last time that trick will work. There will not be much room to refinance our way out of trouble the next time around. Hence why I concerned about still being at the zero bound when the next recession hits.

Moreover, I would find it unlikely that we pass through another two or more years of zero interest rates without seeing capital mis-allocations, assets bubbles, and excessive risk taking. In such an environment, I don't think the Fed is going to be particularly successful in moving the economy off the zero bound without triggering a fresh recession.

Now, it would be easy to take this as criticism of the Federal Reserve. It isn't. The Fed should have moved to open-ended QE long ago to end the problem of arbitrary end dates to policy and needed to clean up its communication strategy to make clear the economic outcomes would define when QE would end. And, probably most importantly, the Fed is compensating for a dysfunctional US political process. I know there is one view (see Raghuram Rajan) that the Fed is simply enabling that process. Perhaps Congress would do the "right" thing if push comes to shove. But what is the "right" thing? If Congress were left to its own devices, would it take us down the road of fiscal stimulus sufficient to spring the economy from the stagnation trap? Or would they continue down the road of additional fiscal stimulus, driving the economy deeper into the trap? My sense is that Congress would find additional austerity to be the path of least resistance. Pete Peterson has won. The Congressional deck is stacked against the economy. And I think Federal Reserve Chairman Ben Bernanke knows this.

Putting all the piece together, I tend to think that neither fiscal nor monetary policy by itself will support a sustained recovery in which the interest rate environment normalizes and fiscal stimulus can be eliminated without fear of renewed recession. The two need to work hand in hand; the Federal Reserve has provided the monetary environment conducive to additional fiscal stimulus. Congress and the Administration now need to take advantage of the environment. Or, alternatively, if the fiscal authorities are not issuing sufficient new financial assets such that there is upward pressure on interest rates, they need to be issuing more.

In conclusion, the above framework both praises the direction of monetary policy without discounting concerns about the dangers of the permanent zero bound policy. A framework that allows for both accepting near-term growth on the back of monetary policy but also concern about the sustainability of that policy. A framework that decisively rejects additional austerity on a simple basis that it will not help normalize the interest rate environment. If nominal rates were 8% then yes, fiscal austerity would help normalize the interest rate environment. But that simply isn't the current situation. Perhaps, if we are lucky, it will be a problem in the future.

I realize that it would probably be easier if I could find myself either advocating the primacy of monetary policy in determining the level of output or deriding the Federal Reserve for the evils of the quantitative easing. Or if I could fully embrace fiscal stimulus as the only solution or austerity as the only solution. Picking one of those quadrant and defending it absolutely would probably make me more friends that straddling all four quadrants at once. But absolute devotion to one quadrant is probably not the right answer. I tend to believe that the right answer is a more complicated mix of monetary and fiscal policy than is currently employed. And don't think we can get to that right mix if we lock ourselves into an ideological box. Hence why I try to avoid such boxes.

Again, sorry for the long post.

Seniors’ Social Security Dwindles

2012-10-18T07:53:00.002-07:00

The Social Security Administration announced that seniors will be getting a 1.7% increase (about $21 on average) in benefits to account for inflation, but experts say that’s not nearly enough to compensate for the costs of actual inflation. Increasing health care expenses and costs for everyday necessities like bread, cheese and milk are making it impossible for some seniors to make ends meet. Some economists argue that seniors do not benefit from low interest rates and things like cheaper electronics, so the so-called benefits that come from economic stimulus and quantitative easing do not really help those who need it most. For more on this continue reading the following article from Iacono Research.

It’s hard not to feel for seniors in their plight to make ends meet every month in this era of freakishly low interest rates and inflation that, purportedly, is almost as low.

Our health insurance premiums have gone up by almost 20 percent per year in recent years (through no fault of our own – I can’t imagine what they’d be if there was something wrong with us), so, I wouldn’t be surprised to learn that the government’s official measure of health care costs, an increase of 4.5 percent from a year ago as detailed here earlier, understate the actual increases that seniors see.

Well, the Social Security Administration announced today that seniors will get a 1.7 percent cost-of-living adjustment starting in January and, while this is surely better than no increase at all (a common feature in many pension plans), since seniors don’t buy near enough of the stuff where prices are falling (e.g., electronics), the average increase of $21 a month will fall short of the actual increase in their expenses.

The realities of some senior’s finances are presented in this CNN/Money story today:

Janis Mason is 94 and has been receiving Social Security benefits for nearly 30 years. Because she has outlived her savings, the monthly checks are her only source of income.
“I always cross my fingers that the money can last the whole month,” Mason said.
…
“We’re grateful for any small increase [in Social Security benefits], but believe me, any small increase doesn’t begin to cover the major increases we’re seeing in things like vegetables, fruits, bread and milk,” said Mason.

Part of the problem is a disconnect between the official inflation figure and what seniors actually pay, experts and seniors say.

The inflation number used to calculate the cost of living adjustment is based on spending patterns among workers of all ages and across hundreds of items. A more accurate calculation would put more weight on the items that seniors purchase most frequently — like food, gas and medical care, according to the American Institute for Economic Research.

“Some months I worry a check might reach the bank before my Social Security check is deposited on the 3rd,” she said. “Other months I might have something left over – lots depends on whether I treat myself to something special at the grocery store, had an emergency, or even bought something to wear.”

What’s maddening about this is that social security benefits are likely to be reduced by the use of a different inflation measure that – surprise! – results in a lower rate of inflation. Sadly, this is one of the few budget related issues that seems to have support from both Republicans and Democrats.

A couple years ago, when inflation in the U.K. was about five percent, the Telegraph calculated a more realistic inflation rate for “pensioners” was close to ten percent. If the U.S. is going to adopt a new, lower cost-of-living adjustment, they should at least change the name to properly reflect what it is accomplishing, say, to something like, PCOLA – Partial Cost of Living Adjustment.

This article was republished with permission from Tim Iacono.

Fed Battles Inflation

2012-10-11T07:05:00.005-07:00

Quantitative easing (QE) has been the weapon of choice of the Federal Reserve and its chairman, Ben Bernanke, to stave off another recession, maintain stable prices and keep interest rates low. The method of flushing the market with currency seems to work in the short term, and some economists argue it can work in the long term, but many people are worried inflation has to come sooner or later, and relying on artificial money generation must be a ticking economic time bomb. Bernanke disagrees (although at this point it’s hard to say whether he has a choice), noting that inflation has been kept at bay for years using (QE). Naysayers argue only time will tell and that QE is too new to predict its consequences, but for now the Fed is willing to take the risk. For more on this continue reading the following article from Economist’s View.

David Altig of the Federal Reserve Bank of Atlanta argues that the Fed's quantitative easing and twist polices were necessary to preserve price stability (Dave will be in Portland, Oregon on Thursday along with Bruce Bartlett and others at the annual Oregon Economic Forum (scroll down) that Tim Duy puts on, and I am disappointed I can't be there this year -- I'm headed to the St. Louis Fed today for a conference):

Supporting Price Stability, by David Altig: All of the five questions that Chairman Ben Bernanke addressed in his October 1 speech to the Economic Club of Indiana rank high on the list of most frequently asked questions I encounter in my own travels about the Southeast. But if I had to choose a number one question, on the scale of intensity if not frequency, it would probably be this one: "What is the risk that the Fed's accommodative monetary policy will lead to inflation?"
The Chairman gave a fine answer, of course, and I hope it is especially noted that Mr. Bernanke was not dismissive that risks do exist:

"I'm confident that we have the necessary tools to withdraw policy accommodation when needed, and that we can do so in a way that allows us to shrink our balance sheet in a deliberate and orderly way. ...
"Of course, having effective tools is one thing; using them in a timely way, neither too early nor too late, is another. Determining precisely the right time to 'take away the punch bowl' is always a challenge for central bankers, but that is true whether they are using traditional or nontraditional policy tools. I can assure you that my colleagues and I will carefully consider how best to foster both of our mandated objectives, maximum employment and price stability, when the time comes to make these decisions."
While the world waits for "take away the punch bowl" time to arrive, here is another question that I think worthy of consideration: "Looking back over the past several years, what is the risk that the Fed's price stability mandate would have been compromised absent accommodative monetary policy?"
As the Chairman noted in his speech, it isn't easy to take the evidence at hand and argue any inconsistency between the Federal Open Market Committee's (FOMC) policy actions and its price stability mandate:

"I will start by pointing out that the Federal Reserve's price stability record is excellent, and we are fully committed to maintaining it. Inflation has averaged close to 2 percent per year for several decades, and that's about where it is today. In particular, the low interest rate policies the Fed has been following for about five years now have not led to increased inflation. Moreover, according to a variety of measures, the public's expectations of inflation over the long run remain quite stable within the range that they have been for many years."
To the question I posed earlier, I am tempted to take those observations one step further. Without the policy steps taken by the FOMC over the past several years, the "excellent" price stability record would indeed have been compromised.
Consider the so-called five-year/five-year-forward breakeven inflation rate, a closely monitored market-based measure of longer-term inflation expectations. If you are not completely familiar with this statistic—and you can skip this paragraph if you are—think about buying a Treasury security five years from now that will mature five years after you buy it. When you make such a purchase, you are going to care about the rate of inflation that prevails between a period that spans from five years from today (when you buy the security) through 10 years from today (when the asset matures and pays off). By comparing the difference between the yield on a Treasury security that provides some insurance against inflation and one that does not, we can estimate what the people buying these securities believe about future inflation. The reason is that, if the two securities are otherwise similar, you would only buy the security that does not provide inflation insurance if the interest rate you get is high enough relative to inflation-protected security to compensate you for the inflation that you expect over the five years that you hold the asset. In other words, the difference in the interest rates across an inflation-protected Treasury and a plain-vanilla Treasury that does not provide protection should mainly reflect the market's expected rate of inflation.
When you look at a chart of these market-based inflation expectations along with the general timing of the FOMC's policy actions, from the first large-scale asset purchase in 2008–2009 (QE1) to the second asset purchase program (QE2) in 2010 to the maturity extension program (Operation Twist) in 2011, the relationship between monetary policy and inflation expectations is pretty clear:

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In each case, policy actions were generally taken in periods when the momentum of inflation expectations was discernibly downward. A simple-minded conclusion is that FOMC actions have been consistent with holding the bottom on inflation expectations. A bolder conclusion would be that as inflation expectations go, so eventually goes inflation and, had these monetary policy actions not been taken, the Fed's price stability objectives would have been jeopardized.

Statements like this do not come without caveats. A perfectly clean measure of inflation expectations requires that Treasuries that do and do not carry inflation protection really are otherwise identical. If that is not the case, differences in rates on the two types of assets can be driven by changes in things like market liquidity, and not changes in inflation expectations. Calculations of five-year/five-year-forward breakeven rates attempt to control for some of these non-inflation differences, but certainly only do so imperfectly.

Perhaps more pertinent to the current policy discussion, inflation expectations have, in fact, moved up following the latest policy action—which I guess people are destined to call QE3. But unlike the periods around QE1, QE2, and Twist, QE3 was not preceded by a period of generally falling longer-term breakeven inflation rates. So this time around there will be another, and perhaps more challenging, chance to test the proposition that monetary accommodation is consistent with price stability. As for previous actions, however, I'm pretty comfortable arguing the case that the price stability mandate was not only consistent with accommodation, it actually required it.

This blog post was republished with permission from Economist's View.

‘American Dream’ Dead, Economist Says

2012-10-04T07:05:00.000-07:00

Economist Joseph Stiglitz makes a compelling argument that the American Dream is a myth during a recent interview for Spiegel. He points out that the political system favors the wealthy and that there are more rich people who attained their wealth through market manipulation and cheating the poor than there are of those who earned it by creating something new that people needed. He argues that there is no other industrialized nation that makes its children more dependent on the wealth and education of their parents to succeed in life, which is the very antithesis of American Dream. For more on this continue reading the following article from Economist’s View.

Spiegel interviews Joe Stiglitz:

'The American Dream Has Become a Myth', Spiegel: ...Spiegel: The US has always thought of itself as a land of opportunity where people can go from rags to riches. What has become of the American dream?

Stiglitz: This belief is still powerful, but the American dream has become a myth. The life chances of a young US citizen are more dependent on the income and education of his parents than in any other advanced industrial country... The belief in the American dream is not supported by the data. ...

Spiegel: We thought that as a rule Americans don't begrudge the rich their wealth, though.

Stiglitz: There is nothing wrong if someone who has invented the transistor or made some other technical breakthrough that is beneficial for all receives a large income. He deserves the money. But many of those in the financial sector got rich by economic manipulation, by deceptive and anti-competitive practices, by predatory lending. They took advantage of the poor and uninformed... They sold them costly mortgages and were hiding details of the fees in fine print.

Spiegel: Why didn't the government stop this behavior?

Stiglitz: The reason is obvious: The financial elite support the political campaigns with huge contributions. They buy the rules that allow them to make the money. Much of the inequality that exists today is a result of government policies.

Spiegel: Can you give us an example?

Stiglitz: In 2008, President George W. Bush claimed that we did not have enough money for health insurance for poor American children, costing a few billion dollars a year. But all of a sudden we had $150 billion to bail out AIG, the insurance company. That shows that something is wrong with our political system. It is more akin to "one dollar, one vote" than to "one person, one vote." ...

Spiegel: So your answer to the inequality problem is to transfer money from the top to the bottom?

Stiglitz: First, transferring money from the top to the bottom is only one suggestion. Even more important is helping the economy grow in ways that benefit those at the bottom and top, and ending the "rent seeking" that moves so much money from ordinary citizens to those at the top. ...

Nothing particularly new here, but I wanted to highlight the point about rent-seeking, anti-competitive practices, etc. once again since I don't think this cause of inequality receives enough attention.

This blog post was republished with permission from The Economist's View.

US Home Price Index Continues Climb

2012-09-26T07:34:00.001-07:00

All signs continue to point to a recovery in the U.S. residential real estate market The summer 20-City Case Shiller Home Price Index shows that property prices increased in June and July. Standard & Poor’s reported that the adjusted numbers were not as impressive, but they were still positive. All 20 cities, which included hard-hit towns like Atlanta and Las Vegas, all showed average gains throughout the summer. The news is dampened somewhat due to the fact that banks are still keeping many distressed homes off the market to juice prices, but experts believe that sales and prices will continue to rise through 2012. For more on this continue reading the following article from Iacono Research.

The nation’s housing market continued to rebound over the summer as Standard & Poor’s reported(.pdf) that the Case-Shiller 20-City Home Price Index rose 1.6 percent in July following a surge of 2.3 percent in June. The most respected measure of U.S. home prices now indicates a gain of 1.2 percent from a year ago.

On a seasonally adjusted basis, prices rose for the sixth straight month with the July gain at a less impressive 0.4 percent, after an increase of 0.9 percent the month prior, however, there is no mistaking the fact that home values are rising steadily this year after languishing for nearly two years following the initial rebound from the 2008 financial crisis and the myriad of home buyer incentives from the U.S. government.

All 20 cities showed gains in July, paced by surges of 3.7 percent in Minneapolis and 3.3 percent in Detroit. Even Atlanta home prices are on a tear as June’s 4.4 percent jump was followed by a 2.6 percent advance in July. On a year-over-year basis, Atlanta is still the clear laggard at -9.9 percent, along with Chicago, Las Vegas, and New York one of only four cities where prices are lower than a year ago and one-time housing basket case Phoenix leads all cities with home price gains of 16.6 percent over last year.

Of course, recent gains are due in part to limited housing inventory as banks continue to hold distressed properties off the market and move slowly on new foreclosures at the same time that mortgage rates have become freakishly low, setting new records just about every day in the wake of the Federal Reserve’s latest money printing extravaganza in which they’ll buy $40+ billion in mortgage backed securities each month.

Don’t you just love it when a good asset re-flation plan comes together?

This blog post was republished with permission from Tim Iacono.