Thursday, June 26, 2014

Grandma Janet's Desperate Easing May Not Work


Unfortunately, at last Thursday's, June 19, 2014 press conference, Janet Yellen all but admitted that she has no clue as to what the future will bring. She stated that it “depends” upon lots of unknown factors. Furthermore, to the dismay of many economists, she positively shaded what the true economic facts are.  Just about every answer that she gave had a positive incredulous spin. This observer believes that as a consequence of her answers, the Fed has lost much credibility as an institution.

The truth is that the Fed is scared about the future and will keep easing via QE at all costs. The Fed’s fear is based upon Ben Bernanke’s and Janet Yellen’s concern about the USA falling into a 1937 type of depression. http://www.frbsf.org/our-district/press/presidents-speeches/yellen-speeches/2009/june/yellen-economic-crisis-federal-reserve-response/ . In my opinion, they will say anything to back up their policy. Let’s examine the facts



Right off the bat at the press conference, Steve Liesman of CNBC confronted Yellen about inflation.  Yellen had contended that the Fed inflation was under control and she was looking for the 2% inflation as the level to use for a change Fed policy. Liesman stated that we are already there.  Yellen then gave some sort of vague non answer denial of that fact calling it “noisy.”  

 http://www.federalreserve.gov/mediacenter/files/FOMCpresconf20140618.pdf Mind you, this was just after the St. Louis Fed had posted official data showing inflation at 2.1% and GDP year growth at -1%.  http://research.stlouisfed.org/fred2/    

A week earlier, internationally esteemed Harvard economist Martin Feldstein had stated that inflation was already over 2%.   http://online.wsj.com/articles/martin-feldstein-warning-inflation-is-running-above-2-1402356356 

Furthermore, we know that our inflation statistics are outdated and faulty beyond any measure of reasonableness. For instance, skyrocketing food prices, energy prices, asset prices for the rich and so on are not properly weighted. Here is an alternative view from Shadow Government Stats: http://www.shadowstats.com/alternate_data/inflation-charts

Another View Of Inflation



Yellen’s non answer made me question any respect that I had for her.  Steve Liesman was polite in his response to Yellen because he has to get along with the people in power. I do not have to be polite. In my opinion, Yellen did not seem to have a grasp of the different types of inflation that we are facing.  She did not explain that the Fed’s fear is deflation, whereby prices go down in a contracting economy. Yet the current inflation is unlike past inflations where strong economies caused consumer demand or higher wages to increase prices. Rather, much of today’s inflation is being caused by other items that are exogenous to the strength of our economy. For instance, food prices are skyrocketing due to shortages caused by drought and diseased beef. Oil prices have been going up because of war in the Middle East. Asset prices for the rich, such as stocks and homes in wealthy areas like New York, have been rising because of the Fed’s QE policy.  Former Reagan Chief Economic Adviser, David Stockman has broken down the various components of inflation:

http://davidstockmanscontracorner.com/what-inflation-shortfall/

Next came Yellen’s disingenuous insistence that employment is getting better. Based upon the government’s dated unrepresentative numbers, that statement is true. However, we all know that chronic unemployment is at historic highs, many standard deviations beyond anything since the great depression. Numerous people who want to work are not included in the government statistics. They should be included in the government's numbers. Janet Yellen knows that, yet she claimed that the historically high chronic unemployment number was just a “cyclical” factor that would correct itself. The chronic unemployment numbers are anything but cyclical and they are way beyond anything in post WWII history. 

St. Louis Fed's chart of the percent of Americans who are employed: 



From my perch, Yellen's insistence that employment was getting better was strike two in the credibility game. The chronically unemployed in the above chart shows the dichotomy between the flawed headline numbers that the public relies upon verses the numbers that the government does not readily show. Many economists agree that if the government’s dated way of presenting unemployment numbers was true, the unemployment rate would be around 10%.

Chronic Unemployment:




Yellen next stated that the Fed was forecasting an improving economy going forward. Unfortunately, the Fed has consistently been wrong in its forecasts.


For example, the negative 2014 first quarter growth blamed on the weather defies logic. Especially when many economic statistics - such as all housing metrics - since the winter persist on being bad.  Yellen gave no evidence of the economy taking off. Essentially, she admitted that there is only hope. Today’s downward first quarter GDP revision must have scared her.

Below is the latest chart from the St. Louis Fed which depicts the 2014 US economy. It includes the minus 1% “growth” of the GDP.  It does not include the June 25, 2014 shocking downward adjustment to minus 2.9% first quarter 2014 GDP, which they have not updated in their chart yet.

GDP Dive
 

Despite all of the Fed’s monetary pumping, things are not good and may be getting worse. The evidence that this is the worst recovery since WWII is replete. Here is an article from the council on foreign relations that depicts the present weak recovery: http://www.cfr.org/united-states/quarterly-update-us-economic-recovery-historical-context/p25774. The economic community is saturated with similar articles and charts such as the one from PEW Research:

 
 

Contrast the above GDP charts and paltry 5 year recovery with the unprecedented pumping by the Fed as depicted by the following chart of the US monetary base from the St. Louis Fed. Something is very wrong, when the Fed gives it all it has and economy responds so poorly:

Insane Monetary Easing
 
Yellen's statement that stock prices were not in bubble territory was true, but did not paint the complete picture. In fact, stock prices do have room to go higher, but they are relatively high on a historic basis.  http://www.bespokeinvest.com/thinkbig/2014/5/20/sp-500-historical-pe-ratio.html

Stock Valuations



Furthermore, Yellen did not acknowledge that earnings have recently been skewed by stock buybacks and financial engineering while revenue growth has lagged – to wit see AAPL and IBM both of whose revenue growth has slowed while profits have risen due to share buybacks funded by cheap debt made affordable by the Fed’s low interest rate policy. Most important is that higher stock prices are supposed to increase people’s wealth which in turn will be spent on the economy. That “wealth” is not going into the economy.

Lastly, Yellen tried to spin the potential bond market liquidity problem by stating that she knew nothing about any Fed discussions regarding the potential problem.  However, he Fed had previously acknowledged the issue in a prior statement about suspending convertibility or using “gates” or fees for redemptions that could create runs. The problem is that there is not enough liquidity in the bond market for sellers to get out without a severe drop in prices. How is all of that money going to get out of bonds when the cycle changes and everyone heads for the exits? http://www.reuters.com/article/2014/05/15/us-fed-moneyfunds-study-idUSBREA4E0VF20140515  in my opinion a run on the bond market would be the 21st Century equivalent of the 1930s run on banks.

In my view, Janet Yellen is praying that the Fed’s QE policy eventually takes hold. In five years it has failed to do so and with the taper ending this fall, another round of QE is possible. If nothing sparks this economy to have at least average growth, the Fed will have created the greatest monetary easing in history for almost naught. Yes, they saved us from a depression five years ago, but that ship has sailed. Furthermore, blaming bad times on the winter does not jibe with poor economic numbers such as housing starts, which fell 6.5% in May: http://www.marketwatch.com/story/housing-starts-fall-65-in-may-to-1-million-annual-rate-2014-06-17?reflink=MW_news_stmp

Housing Starts And Completion:

 

In sum, we are living in a world where the Fed just does not know the answers, but is hell bent on easing in a make or break attempt to ignite the economy and avoid a 1937 repeat. The thought of falling back into a post 1989 Japan like 30 year malaise is anathema to the Fed. The financial community realizes this, but despite its skepticism of the Fed's policy, is absorbed in a chase for yield fueled by easy money. Hence the bond market and stock market rallies have occuered. What choice do asset managers have when given free money by the Fed?  

After Yellen’s press conference anecdotal evidence from the likes of Art Cashin and Steve Liesman on CNBC questioning the Fed's credibility are but two pieces of evidence of the Fed's shaky rationale of its position.   

In short, the Fed's QE program is no longer just a policy issue. but is being treated by the Fed like a political issue. People do not believe in the Fed's logic and do not see a way out of QE. The Fed does not want to scare people, but the problems are self-evident. The size of the QE Mountain is of epic proportions. The economy’s response has been paltry and the Fed has exhausted much of its ammunition. Plus the inflation picture is potentially bad. Many economists still believe that things will get better in the 2nd quarter of 2014. God help us if this unprecedented QE experiment fails. 


BIG Capital Advisors and Seaview Partners are not responsible for your investment decisions. We believe very strongly in our opinions, but you must perform your own due diligence in making your investment decisions.
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