January 29, 2008
Fed May Cut Rate Below Inflation, Risking Bubbles (Update3)
So-called negative real interest rates represent an emergency strategy by Chairman Ben S. Bernanke and are fraught with risks. The central bank would be skewing incentives toward spending, away from saving, typically leading to asset booms and busts that have to be dealt with later.
In hindsight, "later" turned out to be that very summer, as the oil bubble popped.
The Fed tried to keep the Fed Funds rate below inflation for much of the past decade, just like they did in the stagflationary 1970s. As seen in the chart, they failed twice though. Other than housing that popped in 2006, the stock market that popped in 2007, and commodities that popped in 2008, does anyone see any other bubbles forming? Or reforming? Stocks? Oil? China's real estate?
We could also look for something special. Something that might have risen 400% over the last decade and was also popular in the 1970s. Something continuously seen in TV advertisements. Something that historically tracked inflation but then suddenly outpaced it. Something far more precious to us than aluminum, and at any price. Gold?
I should point out that one way the Fed could fail a third time is if we simply slide into deflation. That would certainly push the low Fed Fund's rate into positive real territory, again.
But which comes first? The chicken or the egg? If everyone flees risky assets simultaneously then deflation will arrive and prove that everyone should have fled risky assets simultaneously. I guess that means that the chicken would come first. The nest egg would just be left behind. Or... maybe nobody panics. It's just a theory.
It is also possible that I'm just seeing bubbles where they don't exist. Maybe there's a "veritable bubble in bubbles".
Source Data:
St. Louis Fed: Effective Federal Funds Rate
St. Louis Fed: CPI
By the way, the source of that "veritable bubble in bubbles" link was actually Barry Ritholtz over at The Big Picture.
ReplyDeleteEpic Fail.
One more thought from the link above...
ReplyDeleteBut a 25%-35% retracement is a very different situation than a bubble (recall that the Nasdaq dropped 80%), primarily because there are very different consequences for both homeowners and investors.
I would agree.
If an investor bought $50k worth of Nasdaq stock and lost 80%, then that investor would have lost $40k. He'd still have $10k left though. No government bailout needed.
If an investor bought a $500k house, put that very same $50k down, and the house then lost 35% of its value, then that investor would have lost $175k. That's more than 3x his original investment. Not only would he have nothing left, he'd owe still owe $125k more than the house is worth.
Those are two entirely different consequences all right.
Further, some people might even start selling off the stock market once they realize the gravity of the situation. In fact, companies like AIG, Citigroup, and Fannie Mae might make the Nasdaq bubble stocks look pretty good by comparison, even with MASSIVE government support.
Stranger things have happened.
Forehead. Desk. Whack. Whack. Whack.
Mark, I noticed on the Yahoo boards you say you do not hold TIPS in your retirement account. Why not? I looked at my TD Ameritrade Roth IRA and it allowed me to buy actual TIPS ($25 dollar fee.) Is there any reason not to buy individual TIPS bonds in an IRA account?
ReplyDeleteSecondly, I just recalled another reason why capital gains tax should be zero percent: because oftentimes the nominal "gains" are simply from inflation. So if you made 15% over 5 years assuming 3% inflation, you are being taxes for inflation, not for actual capital gains. (I know the math is actually different but you get the gist.)
Coba
Coba,
ReplyDeleteNo reason not to own TIPS instead of TIP in an IRA. I could probably even save a bit of money. However, my retirement account is only about 10% of my investment nest egg.
I'm paying 0.2% per year in TIP fund expenses but since I'm using a dividend reinvestment plan to automatically buy shares, that's actually my only fee. That's $20 per $10,000 per year.
Buying TIPS directly also means that you have to do something with the proceeds as they come in. That could also require fees too depending on what you did with them.
I would eek out a bit more by doing it directly, but there's something to be said for having it all done automatically. Further, if TIP went to $110 I could bail on all of it with just one ETF transaction.
Hard to say what is better long-term. The more you have, the better individual TIPS look though.
As for capital gains tax taxing the inflationary gains, that's all part of the inflationary tax system. It is by intent. That's one reason the government hates deflation so much. It loses out on revenue.
Take gold. The government doesn't really want it to be a safe store of value. By taxing it as a collectible at the higher 28% capital tax rate, the only way it makes sense to hold it long-term is if you think it can appreciate faster than inflation overall.
Mark, let's say the Euro and some other currencies go up, prompting the USD to go down enough to maintain the dollar value of the DJI... let's say the dollar is low enough that exports surge...
ReplyDeleteWhat i find odd is that the MSM is mentioning the possibility of a double-dip. they are usually the last people to predict anything (this is the contrarian in me speaking)... Unless they are trying to sell us another stimulus.
remy
remy,
ReplyDeleteYou feel that the MSM is often wrong yet they are predicting a double-dip recession which feels somewhat right?
From a contrarian standpoint, this makes you somewhat uneasy and uncertain?
Let me ease your concerns. There is a small probability that we actually can't double-dip. In theory, it could be impossible.
US Business Cycle Expansions and Contractions
NBER has yet to confirm that the recession has ended.
April 12, 2010
NBER COMMITTEE CONFERS: NO TROUGH ANNOUNCED
Although most indicators have turned up, the committee decided that the determination of the trough date on the basis of current data would be premature.
Can't have a double-dip recession if we are still in the first one. NBER is always extremely conservative when it determines dates. It does not have the proof it seeks yet. There's a good chance the recession did end and they are just trying to fine tune the exact ending date. It is also possible that the recession did not end.
The Chinese will not let the USD weaken until they feel its safe for them politically. They will continue to buy USD for as long as they can. If we get angry at them, they will do as they did recently and buy JPY, which forces Japan to buy USD to stop the JPY from appreciating, but also nicely does the same thing as having China buy USD but putting the blame on the Japanese. The Europeans could be put in the same spot, but they won't buy USD - I think their officials can easily devalue the EUR simply by scaring people about their banking system.
ReplyDeleteIf the US finances get really scary and rumors of default start, then the USD could weaken. If China gets mass inflation or decides it has to act responsibly (not something any government likes to do) it might allow some appreciation.
The US consumer and open market was the engine of growth for 40 years - now it cannot perform that role, but who will step up to the plate? Everyone is looking at someone else.
Coba
Coba,
ReplyDeleteIn other words, eveyone wants their currency weaker than everyone else's to boost export growth relative to everyone else.
Meanwhile, everyone wants their currency stronger than everyone else's to lower the cost of oil and thereby contain inflation better than everyone else.
I therefore propose that we adopt a strong and weak dollar policy to boost exports and reduce the price of oil, lol. Sigh.
Mark, Coba,
ReplyDeleteDuring the 08 dip, major economies of the world passed stimulus bills. So, debt to GDP placements did not vary much, and the relative risk of one currency vs another did not vary much (as a result of stimuli).
China had a real estate bubble to help the world economy. this was a sacrifice. There is no (imo!!) aggression between the US and China or Japan. All of that is fake MSM lies that have the purpose of directing public anger/blame over a crappy life to a foreign enemy.
When China collapses, oil will drop, and if the USD drops too. then we will have an ideal situation int he US for exports (and relatively cheap fuel)...
just my 2 cents
remy,
ReplyDeleteAll things being equal, I think if China collapses and oil falls then I would expect to see the USD rise.
That's what it did when oil fell in 2008.
USD Chart
Also consider...
June 7, 2010
Why a Rising U.S. Dollar Is Horrible News for China
Tom Dyson writes: Hugh Hendry is the famous British hedge-fund manager who predicted the banking crisis and made 40% in 2008.
...
Hendry says if the dollar continues rising, you're eventually going to see a depression in China and possibly the rest of Asia. Commodities will also collapse... especially the commodities China buys in big volume, like cement, steel, aluminum, copper, and iron ore.
...
But the safest way to bet on chaos in Asia and a massive dollar rally is to hold cash in U.S. dollars.