Dear Diary,
New York is filling up with holiday shoppers and tourists. On Saturday, we went to the Broadway show Jersey Boys.
It was not an especially complex or subtle storyline. But the music, of Frankie Valli and The Four Seasons, was lively and agreeable. It took us back to the early 1960s.
Those were the days!
Back then people had jobs… prices were fairly stable… and the GDP was growing at twice or three times today’s rates (and so were personal incomes).
How was it possible?
Back then, under chairman William McChesney Martin Jr., the Fed ran much tighter monetary policy. So America’s savers could earn a decent return on their money. And the Fed wouldn’t have even dreamed… let alone dared… to target higher stock market prices.
What about quantitative easing?
It was probably illegal. And certainly would have been considered immoral or insane.
But there are fads in music… and in central banking, too.
The music industry has given us “twerking.” (Google it.) And in central banking, we have multitrillion-dollar asset price manipulation programs. Both are obscene. But both are popular. And almost nobody wants to see them stop.
But in the end Mr. Market… nature… and the gods… will prevail.
Thy will be done. It always is.
Defying the Gods
As we closed out last week, US stock market benchmarks were climbing to new highs. And gold was taking a $17-an-ounce hit.
But what happens next is not up to us. It depends on the gods, who represent the forces of “what shall be,” not “what we want things to be.”
All we know is the Fed cannot control the outcome. Nor can individual investors. Nor Paul Krugman. Nor the president of the US. Not even Warren Buffett or the NFL can dictate the terms of this story.
You can tinker with nature… you can bend and twist the markets… you can delay and outrage the gods… but you can never control them.
If smart, well-informed people, armed with modern theories and “policy tools,” could control an economy or a market, why would there ever be meltdowns, breakdowns or shakedowns?
Why would Zimbabwe’s currency become worthless? Why would Venezuela be feeling “the hurtin'”? Why would Japan’s GDP be the same as it was 25 years ago – despite a quarter of a century of “stimulus”?
No, dear reader, even the most powerful policymakers and the smartest theorists cannot defy the gods. In the end, we don’t get what we want; we get what we deserve.
Cheap Gas!
Now, thanks to our enlightened economists and their careful management, we’re told, the US economy is doing quite well. Reports the New York Times:
On Friday, the Labor Department reported that US payrolls rose by 321,000 jobs in November and that hourly wages jumped, easily beating economists’ expectations. This year will be the best for job creation since the boom years of the late 1990s.
Meanwhile, federal deficits are falling. And you can buy a gallon of regular gasoline for $2.71 – only five times the price of when Ike and Dick were “sure to click.”
The Fed says falling prices are bad. They are adding trillions of dollars to the monetary base to make sure the consumer price index rises by its target of 2% a year.
But falling oil prices are a good thing. Do we have that right? Sometimes we can’t remember.
Let’s see, Americans can spend less on gasoline, leaving them more to spend on other things. Heck, we don’t need no stinkin’ QE anymore. Now we have cheap gas!
Wait. Since the crisis of 2008-09 about one-third of capital spending by S&P 500 companies went into energy. And as much as 20% of the high-yield market (junk) now is concentrated in the energy sector.
That boom was built on low interest rates and a high oil price. Without cheap money, cheap gas wouldn’t be possible. And when gas gets too cheap, the cheap money suddenly gets very dear.
Nearly a trillion dollars of spending worldwide is focused on new energy production. And with oil prices down nearly 40%, much of that spending… and all the subprime energy debt… is in danger.
Unless oil prices go back up soon, there could be hell to pay.
The Saudis seem to be determined to keep on pumping, despite plunging crude oil prices. The only way they can protect their market share is by remaining the low-cost producer.
US frackers are likely to keep fracking too. They’ve bet big money on forcing crude out of grudging rock. They won’t give up easily. Instead, they’ll borrow more heavily to stay in business. But the more they pump… the longer oil prices stay low.
Paying $60 to extract a $50 barrel of oil is not a good business – no matter how low interest rates are. Already, the gods have smashed the oil companies, the drillers, the transporters and almost everything else that reeks of gasoline. Soon, they’ll whack at their subprime debt too.
Will they bring down other stocks? Bonds? The economy? Only a fool would pretend to know.
As to twerking, your editor hasn’t made up his mind. But as to the Fed and its meddling in the markets, he is sure: Less is more.
Trying to manage an economy is like trying to manage the love life of a teenage daughter, it’s just going to make things worse.
Regards,
Bill
Jobs News Ups the Odds of a 2015 Rate Hike
Friday’s news that the US economy added 321,000 nonfarm jobs in November sent the US dollar to new heights.
The US Dollar Index – which measures the exchange value of the dollar versus a basket of six trading-partner currencies – rose 1.2% for the week.
That leaves the index at its highest level since all the way back in April 2006 – close to the peak of the US credit bubble.
Friday’s jobs report was the tenth in a row that saw the US economy add more than 200,000 jobs.
That leaves the official unemployment rate at 5.8% – or about half the European Union rate of 11.7%.
And it’s just 10 basis points higher than the 5.7% unemployment rate the Congressional Budget Office (CBO) reckons is the “natural” unemployment rate.
Some rate of unemployment is inevitable in an economy. Right now, the CBO reckons about 6 out of every 100 Americans looking for jobs will remain out of work for underlying structural reasons (i.e., reasons outside the Fed’s control).
That means the current 5.8% jobless rate is also close to the point at which wage pressure will start to build… and with it inflation pressures from rising wages.
This is already starting to happen. Hourly earnings rose 0.4% in November – nearly twice the rise Wall Street economists were expecting.
Wage growth is one of the indicators the Yellen Fed is watching closely. So this – plus a jobless rate butting up against the natural unemployment rate – will up the odds of a rate hike sometime in early 2015.
If rates rise, it will be bad news for bondholders.
As interest rates rise, new bonds carry a coupon rate – the interest rate stated on a bond when it’s first issued – that reflects higher interest rates. This pushes down the prices of bonds that carry a lower coupon rate.
After all, who wants to buy an old bond with a coupon rate of, say, 2% when they can spend the same money on a new bond with a coupon rate of 2.5%?
Only by discounting the price can sellers of lower-coupon bonds compete.
Higher wage costs will also put pressure on US corporations’ profit margins, as they will have to use a bigger percentage of their revenues to pay for labor costs.
If profit margins start to fall, it’s a good bet that overvalued US stocks will follow suit.
We’ll continue to watch this story closely… But don’t be surprised if US stocks and bonds come under pressure in a world where the dollar is king.