What Can the Stock Market Tell Us?

Over the last year the stock market has been on a wild roller coaster ride. The question is, Why is this so important?

Here is a good analogy for what stocks do: Pretend that the USA's economy is a car; the current recession is a very bumpy road (probably designed by Commerce City road developers); and the stock market represents the vehicle's shocks.

When the economy is good, there is almost no tension on the shocks and the passengers in the USA economy are driving smoothly and comfortably. When the vehicle exits the nice road and enters Commerce City, the shocks are knocked every which way and pounded into a pulp. This puts a lot of tension on the shocks and the passengers are whipped around and every once in a while thrown out of the car.

The stress put on the shocks of the car tells you how comfortable a ride the passengers in the vehicle will have. Similarly, when there is a lot of stress in the stock market, the USA's economy is put under a lot of stress BECAUSE STOCKS ARE USED AS COLLATERAL FOR INVESTMENT!!

When a corporation wants to invest, it needs to raise funds. On average, corporations only raise funds through selling shares of stock for 3% of their investments. Selling bonds is where the real money is made! Therefore, corporations tell potential bondholders that if anything ever happens to the company and they have to go bankrupt, the bondholders can take all of the stock that the corporation has. This means that when stock prices are high there is more collateral and more investment. When stocks are not worth much, nobody can invest and the economy does not grow.

Has Bernanke Printed A Lot of Money?

When politicians and political pundits want to sound smart and make headlines, they begin oversimplifying things that they don't understand. Accordingly, the last several months has seen an increase in the accusation that the Fed has "printed money."

As stated above, though, this is way oversimplified. Normally when the Fed wants to print money, it gives cash to banks in exchange for an asset like a T-Bond or fixed income security. Then the bank can spend that money however it wants by giving consumers, homeowners, and business owners loans.

Chairman Bernanke made a decision though. He analyzed the crisis and found that banks needed liquidity (cash), but consumers, homeowners and business owners should not be the end-recipient of this money because inflation could get out of hand in the long run. He therefore went to Congress and asked for permission to pay interest on the extra money banks keep at the Federal Reserve. This way, the banks would make as much money by doing nothing than they would by giving loans to the public (this is because the interest rate paid by the Fed is almost equal to the interest they would recieve in profit from a loan).

This gives the Fed a great tool to fight inflation. The Fed hasn't printed money because almost all of the cash that has been given to banks is sitting UNUSED in the bank's account at the Federal Reserve! At the same time, banks meet liquidity standards by having the money held with out issuing a loan.

Bernanke: Better Than Advertised Part II

The Federal Reserve has to maintain stable growth while stifling harmful inflation. This is a balancing act because to stimulate growth you sometimes have to expand the monetary base which stokes the flames of inflation.

Here is an extremely important analysis by Econometrician James Hamilton. It analyzes the Fed's Balance Sheet and the options it has to "un-print money."

http://www.econbrowser.com/archives/2009/09/federal_reserve_2.html

Bernanke: Better Than Advertised!

Bernanke, probably the most underpaid individual in America, really is as good as The BBFiles made him out to be. Some just might say miraculously good...


http://www.bloomberg.com/apps/news?pid=20601087&sid=ayo1J7aDXneM

How Did Economists Miss This Downturn?

Last week Paul Krugman initiated a sequence of discussions centered around how and why the current recession blind sided economists as badly as it did. Other famous economists have jumped into the conversation, including Mark Thoma, James Delong and James Hamilton. It appears as though most of these economists "blame the other guy." For example, Paul Krugman, who is a Neo-Keynsian, basically argues that he was SO busy correcting Neo-Classical's mistakes that he totally missed the recession's warning signs. Liberals seem to blame Greenspan and Conservatives seem to blame... well Greenspan also.

The BBFiles, your trusty guide to unbiased economic analysis, disagrees with most of these economists. The study of business can be split into several fields: economics, finance, management, marketing, entrepeneurship. It appears as though economists have been assigned most of the blame for this recession. In reality, though, The BBFiles argues that the products that got us into the recession, the way they were traded, and and the people that were assigned to manage them, lie far outside of the field of economics. Financial wizards created MBS's, marketers sold them to as many people as possible, management teams gave employees incentive to stimulate short term profits, not long term growth. Lobbyists influenced Congressmen, Congressmen did what Congressmen do: spend a lot of money.

All of these things, which the field of economics does not specialize in, created a perfect storm of instability that led to this recession. It was economists of several different belief systems that stepped in via the Federal Reserve and the Treasury Department and saved financial traders, management teams and Congressmen from the debacle that they created. While economists like Krugman believe that he is right and everyone that disagrees with him wrong, the BBFiles appreciates the diverse ideas and the new theories that come from debating controversial issues.

America's Lost Wealth

According to a press release from the Federal Reserve on Tuesday, American households gained about $2 trillion in the 2nd quarter- the first time it has increased since 2007. The Flow of Funds report also showed that the current net worth of American households is $53 trillion. The highest it reached was $65 trillion in 2007. In the 4th quarter of 2008 alone, the total dropped a record $11 trillion.

The Fed's Balance Sheet

The Fed's balance sheet determines how much money is in circulation. When they want to put more money into the system ("print money") they BUY assets (bonds) from banks. Since they use cash to pay for the bonds, there is now more cash in the system.

When the economy goes into a recession, the Federal Reserve can stimulate the economy by injecting more money into the system. This blog entry examines how the Federal Reserve's balance sheet has changed over the last year. Before the recession began, the Fed's balance sheet had $800 billion on it. When looking at the balance sheet, one would see that $400 billion of the total was compromised of a mixture of long term T-Bonds and other safe bond investments. The other $400 billion was compromised of super-safe T-Bonds that expired every 1 to 6 months. For decades the Federal Reserve simply repurchased these short term bonds when they expired.

When the recession began, the Federal Reserve, in as safe a way as possible, began purchasing bonds directly from banks and other lending institutions. This injected cash into the system, but did not grow the Fed's balance sheet because the Fed offset the purchases of bank bonds by not repurchasing the "super-safe" short term T-Bonds. Thus, the balance sheet remained at $800 billion but added a little more liquidity and took on a little more risk.

When Lehman Brothers collapsed, and the LIBOR-OIS spread grew exponentially, the Federal Reserve decided to expand the balance sheet. This proved to be a difficult task. The Fed had a balancing act to perform: they had to inject enough cash into the system to keep the financial system afloat; but they also had to make sure the bonds they purchased along the way could be sold off easily when the recession ended (if the balance sheet remains at $2 trillion there is sure to be inflation). Chairman Bernanke was up to the task. Bernanke and the Federal Reserve found the safest bonds on the market, then from these selected bonds, they picked the ones that would would sell the fastest once they needed to be sold.

Therefore, the Fed's balance sheet, though huge today at $2 trillion dollars!, will be "drawn down" easily. Drawing the balance sheet down refers to exiting the Fed's added liquidity. Inflation will not occur from the Fed's large balance sheet because the bonds will be sold promptly by the Federal Reserve at the opportune time.

This quick, decisive action will certainly go down positively on Bernanke's resume.

Evidence That the Stimulus Didn't Work

Three respected economists wrote an editorial in the Wall Street Journal today arguing that the stimulus failed. While The BBFiles doesn't like using strong words like "fail" (we don't have to make headlines), the article is very interesting and should be read by Congressmen in Washington.

The BBFiles does not believe that President Obama's highest advisers (Larry Summers, Paul Volker, Christina Romer and Timothy Geithner) ever believed too strongly in the stimulus plan. Congressmen, who are mostly responsible for the plan, should try to pass this argument along to their constituents.

The BBFiles believes that stimulus can work. However, there is an enormous diminishing return after teh $500 billionth dollar, and since Bush was already stimulating the economy by this amount via tax cuts, there really was no need for such a large stimulus bill. Probably about an additional $250Billion would have been more than enough.

Here is the link:

http://online.wsj.com/article/SB10001424052970204731804574385233867030644.html

A Sad Anniversary

One year ago today, Lehman Brothers was allowed to file bankruptcy. This will go down as the primary flaw in Bernanke's othrewise impeccable resume. Political will basically forced the Fed and Paulson "to let the markets work." Within 24 hours of the Lehman collapse, FannieMae, FreddieMac, Wachovia, and AIG were completely insolvent. Clearly, in hindsight, an uber-regulator should have had the authority to step in and prevent Lehman from failing.

Let's look at the USA's tab from this bad policy:
Lehman Brothers......$766 Billion bankruptcy
AIG......$250 Billion in direct cash infusions
FannieMae....$250 Billion in cash, $1 trillion in garuantees
FreddieMac... " " " " " "

American citizens: A tariff implementing president and 10% unemployment

The costs are way too high!!! The Fed needs the power to sieze systemically important companies, just like the FDIC has the power to sieze banks.

A Closer Look at the Tariff

The BBFiles has generally supported the Obama Administration's economic policies. However, Obama has given into union demands and passed a terrible tax on rubber imports, and we cannot support this mistake. Even though Bush rejected the United Steelworkers tariff request four times, Obama gave in to this bad economic policy right away.

The tariff imposes a 35% tax on all rubber imports from China. This hurts the Chinese and American citizens in several ways. First, it means that the USA can sell lower quality rubber and be 35% less competitive in the rubber industry. Second, it hurts American companies that sell low-end rubber tires. This is basically every retail tire store. Next, it puts Chinese companies out of business. Remember, these are companies that SPECIALIZE in rubber manufacturing and can achieve high quality tires for low prices.

Essentially, the 35% tariff is a hand-out to uncompetitive American companies.

Bloomberg reports this about the nation's largest union, the AFL-CIO:

AFL-CIO Reaction
AFL-CIO President John Sweeney applauded the decision in a statement today, saying it “sends a strong message that the U.S. government will take the necessary action to ensure that American workers and producers can compete on fair terms in the global economy.”

Bloomberg says this about how American companies voted, this is interesting because if the tariff supposedly helped American companies, all US companies would approve. But Bloomberg reports:

Goodyear Tire & Rubber Co., the largest U.S. tiremaker, stayed neutral. Cooper Tire & Rubber Co., the second-largest U.S. tiremaker, opposed the relief. Imposing tariffs will have “highly damaging ripple effects throughout the U.S. economy by increasing the cost of imported tires that largely comprise the low-end of the tire market,” the Emergency Committee for American Trade, which represents those companies, wrote in a letter to Obama last month.

Really! A Tariff?

Obama has officially enacted a 35% tariff on rubber tire imports from China. Hopefully this is a last terrible move that comes from Obama's administration.

The Economics of Being a Jerk

As The Bernanke Files has repeatedly pointed out, the media, journalists, and political pundits have more of an incentive to make headlines than to be accurate. If your a logical, pragmatic critic you won't make any money and will never be famous.

Well, as it turns out politicians have similar incentives. During Barack Obama's speech to the Joint Session of Congress, South Carolina Republican Senator Wilson yelled "You lie" when the president discussed not insuring illegal immigrants. This was not an off the cuff remark. Wilson said he let his emotions get the best of him. This is ridiculous, of course. Politicians know that to get headlines these days they can do two things: give an interview on Sunday, or do something outrageous. Since we know politicians aren't giving up their Washington Party day, we can basically conclude that outrageousness is the best way to get their name out to the public. Wilson knows this and succesfully captured headlines with his outbreak.

Credit Tightening- Savings Increasing!!

The Bernanke Files has written extensively about where money comes from. Today the Federal Reserve released the monthly Credit-Demand report. Demand for credit has dropped significantly. This means that, because credit is the opposite of savings, savings in the US has increased. When there is more demand for savings, bond yields go down; thus making investment easier.

In other words, from 1997-2007, the USA went into debt with China to the tune of a trillion dollars. But, savings in the USA is now UP, so we will not go as heavily into debt to China as we will to American savers!! At the same time, economic growth will slow in the USA because we SAVE money instead of borrow money that we can SPEND. Of course when Americans buy less, China makes less money. To avoid this problem, the government will SPEND more and they will SAVE less. Chinese demand for US-TBonds is being replaced by AMerican demand for T-BOnds, and everything is coming into equilibrium.

USA Drops to Second Place

According to the newly released Global Economic Competitiveness report, USA has dropped from being the most competitive economy in the world to the second most competitive economy. Replacing it is Switzerland, and following USA is Singapore. Here is what the report summarized:

Switzerland’s economy continues to be characterized by an excellent capacity for innovation and a very sophisticated business culture, ranked 3rd for its business sophistication and 2nd for its innovation capacity. The country is characterized by high spending on R&D.

The United States falls one place and is ranked 2nd this year. The country continues to be endowed with many structural features that make its economy extremely productive and that place it on a strong footing to ride out business cycle shifts and economic shocks. However, a number of escalating weaknesses have taken their toll on the US ranking this year…. More generally, given that the financial crisis originated in large part in the United States, it is hardly surprising that there has been a weakening of the assessment of its financial market sophistication, dropping from 9th last year to 20th overall this year in that pillar.

Singapore moves up two ranks to 3rd place, remaining the highest-ranked country from Asia. The country’s institutions continue to be ranked as the best the world; at a time when confidence in governments in many countries has diminished, they are assessed even more strongly than in past years. Singapore places 1st for the efficiency of its goods and labor markets and 2nd for its financial market sophistication, ensuring the proper allocation of these factors to their best use. Singapore also has world-class infrastructure (ranked 4th), leading the world in the quality of its roads, ports, and air transport facilities. In addition, the country’s competitiveness is propped up by a strong focus on education, providing highly skilled individuals for the workforce. In order to strengthen its competitiveness further, Singapore could encourage even stronger adoption of the latest technologies—especially broadband Internet—as well as the innovative capacity of its companies.

A Look Back

To this very day economists debate the actions, inactions, choices, missed opportunities and risks that President Franklin Roosevelt has become so very famous for 70 years ago. Elected in the midst of a recession, Roosevelt showed the world what his tenure would be like on just the thirtieth day of his presidency when he declared a bank holiday. In late February 1933, Roosevelt closed every bank across the nation, then he told the American citizens via radio that their deposits would be insured by the government. Even though the government had no authority to insure deposits, Americans believed him and the financial crisis subsided. Over the next several years Roosevelt would enact hundreds of initiatives in an attempt to turn the economy around. In hindsight, it is generally agreed that about 25% of initiatives did good, 50% did little or nothing, and 25% actually harmed the economy.

The Bernanke Files believes that 70 years from now, economists will be debating the current economic policies in a similar manner. Enormously expansive and creative monetary policy, $1 Trillion stimulus, health-insurance reform, increased unemployment and other government initiative's helpfulness will be debated.

Fortunetly, though, the debates will never be as famous as the Great Depression debates because of the Great Depression. Ben Bernanke is a Great Depression scholar. Because of his creativeness and guidance, our current crisis is merely a recession. A scary fact is that it could have been a depression. In 70 years, just like Bernanke argues that monetary policy, not government intervention, helped us climb out of the Great Depression, economists will be arguing that it was the Federal Reserve that incurred some of the damage but most of the stabilization in the markets. Because we learned from the Great Depression, great Americans like HenryPaulson, Ben Bernanke and Timothy Geithner will be taken for granted in the 70 years.

The Savings Glut Hypothesis

One of Ben Bernanke's most controversial theories is his Asian Savings Glut Hypothesis. The Asian Savings Glut Hypothesis shows how high savings rates in China effects the supply, demand and prices of US goods and how these three factors affect US wage rates, unemployment rates, and yields on federal debt (T-Bond Yields).

Here is a brief explanation of how Bernanke sees the interactions between Asia and America. Pretend, for a second, that there are two countries, one named China and the other named the United States. These two countries compete with each other to sell as many basketballs and basketball shoes as possible. China decides that the best way to compete with the US is to keep wages (the amount of money manufacturing employees make per hour) as low as possible. This ensures China that when a consumer is at the store looking at basketballs and basketball shoes, the balls and shoes on the Chinese aisle are always cheaper than the balls and shoes in the US aisle. Therefore, assuming Chinese made balls and shoes are the same quality as US balls and shoes, the Chinese have become more competitive than the US and consumers will buy more Chinese goods than US goods.

That is a simple, obvious concept. The complexities of the Asian Savings Glut Hypothesis occur when we ask how can China constantly keep wages low while at the same time keeping the ball and shoe consumers rich enough to afford the balls and shoes?

The concept that expains this is called the Balance of Payments and will be explained further in the next blog. The balance of payments concepts simply says that money MUST go somewhere. If a consumer pays $10 for a basketball and a ball, and they cost $3 to make, the extra $7 must go somewhere. In America, the $7 would go to wage-earning employees, shareholders, banks, credit cards, etc. In China, since they are trying to keep wages as low as possible, the government creates policies to make sure the extra $7 goes anywhere but to the wage earning employees, credit cards, banks, etc. In fact, the banks are so controlled by the government that loans are dictated to go to only two places: low interest rate loans to large manufacturing companies; or to the purchase of US T-Bonds. When China buys a T-Bond, many effects occur. These will be discussed in the next blog.

Bias Economists

The Economics profession has taken a lot of criticism lately for its response to the recession.

The Bernanke Files prides itself on being a pragmatic, unbias analyzer of economic policy. The Bernanke Files believes that most of the well founded criticism of economics probably stems from the political bias and ideological rants that many pundits spew everyday.

For example, today's Paul Krugman Blog exemplifies the profession's ignorant biases. Krugman criticizes Bush for going into debt to the tune 0f $500B. Then every comment is a total acceptance of Krugman's statement, its like his audience is... liberal! So of course he is speaking down to his audience.

But, has humanity come to such mindless, thoughtless following? The Bernanke Files thinks not! The debt had to come from somewhere. The two questions one must ask to be fair are: How much did we pay for the money? (Answer: a measley 3-4%) And is the benefit we recieve from the debt greater than (3-4%+addt'l unseen costs)? Keep in mind that if we did not go into debt, employment or wages (or a combo of both) would be considerably less than it is now.

While many of these questions are semi-rhetorical, it is interesting that Krugman does not even mention the cost/benefit analysis in his anti-Bush rhetoric. When the average reader crosses this, how could he become anything but skeptical at the economics profession?

A Few Thoughts and Updates

Now that Obama has made the mind-numbingly easy decision of re-appointing Bernanke as Chairman of the Federal Reserve, a few loose ends need to be tied up. First, we are taking Laurence Summers, head of Obama's economic council, off of the Bernanke Arch-Nemesis list. Replacing Summers will be Kentucky Republican Senator John Bunning. Today, in a show of splendid ignorance, Bunning criticized Obama's decision. Then Bunning proceeded to criticize Bernanke for what Bunning called a "delayed response" to the crisis. This puts Bunning on the dreaded Bernanke Arch-Nemesis list and is a good lead into the next loose end that needs to be tied up.

The Bernanke Files argues that Bernanke's response to financial crisis was late... and occurred at the exact right time. Let me explain: to be fair, one must look at Bernanke's response in context with the Federal Reserve's day to day environment. If you a critic says, "Bernanke should have speculated about the future of the economy and put into motion drastic measures to stave off the recession," then it is only fair to say that "Bernanke should ALWAYS speculate about the future economy and put into motion measures to stave off the recession." This means that when unemployment was going from 7% to 3.9% but half way down it turned around for a month (from 5% to 5.1%), Bernanke should have closed down AIG, Bear Stearns, McDonalds and urged Congress to pass Armeggeddon resolutions mandating the purchase toilet paper and water by every American citizen.

But, the Federal Reserve DOES NOT SPECULATE- as crazy as it sounds, the Fed actually waits for facts and data to come to them, then it makes the best decision it can with the resources it has at hand. This maintains confidence in the Fed, and makes sure its decisions are not too drastic, or not enough.

In hindsight, of course Bernanke's response was late... by 20 years. Bernanke, Bush, Clinton, Summers, Bush 1, Reagan, Greenspan and every Congressmember since the 1980's could have made the sub-prime mortage backed security market less leveraged, yet none of them did because rational people don't look into crystal balls to make decisions.


Firstcongerss bunning rule second summers of arch nem

BREAKING NEWS: Bernanke Re-appointed!!!!

The Executive Branch has done little right over the last several years. Today, though, this trend paused for a moment when Barack Obama re-appointed Chairman of the Federal Reserve Ben Bernanke to another 4 year term.

Obama joins George W Bush as being members of the very prestigious club of presidents that has appointed Ben Bernanke as Chairman. Though Bernanke has a long road of him in dealing with the recession and exiting the current monetary situation, he is the right man for the job, hands down.

Bernanke has overseen the worst liquidity crunch in over 70 years. He reacted to the crisis by expanding the amount of money in the financial system. What he will truly go down in history for is his ability to add so much money into the system at the extremely low risk levels that he did; and for adding so much liquidity while keeping in mind he would have to undo the expansion shortly. These two measures have kept faith in the dollar and interest rates low- two important factors for future growth.

Stimulus vs. Monetary Policy

Monetary policy stimulates the economy by determining the amount of money that is injected into the banking system each month. Fiscal stimulus is money spent directly by the federal government on various projects.

While The Bernanke Files is not totally anti-Stimulus, it has concluded that the current stabilization of the economy had little or nothing to do with Obama's stimulus plan. Several weeks ago, before the "popular" indicators showed economic stabilization, Liberal commentators said the stimulus plan hadn't yet worked because most of the stimulus plan has not been spent. Now, after the "popular" indicators are turning around, those same commentators are saying "See, we told you so! Of course the stimulus is working." In reality, though, ONLY $25 Billion more dollars has been spent since then!!! In a $14,000 Billion economy, of course $25 Billion will make virtually no difference.

There is other evidence that shows that stimulus has done little, much less than the efficiently crafted monetary policy has done. First, if stimulus was working, one would expect people to go out buy things like clothes, toys, toothbrushes, etc. But, as was reported this week, retail sales declined by MUCH MORE THAN ANTICIPATED. Clearly, to any unbiased spectator, one would have to be skeptical of saying the stimulus plan had much, if anything, to do with the turnaround.

Conversely, monetary policy is having a large impact. Econ101 says that stimulus plans work because it replaces the "fearful" investor/consumer spending with government spending. This time, though, the Fed has crafted such efficient monetary policy that interest rates are declining (A2/P2 is way down, the LIBOR-OIS spread is almost back to normal). This makes investors invest more because they can borrow money for less than what they will make off of the money. Investors in turn employee consumers who can then spend money. The Bernanke Files believes the first step, investors investing more, is beginning to take place. Next, down the road, unemployment will turn around because of investment, not the stimulus plan.

Economics Riddle Solution

Several blogs ago the audience was asked what China did with the extra money it receives from having more imports than exports. The technical name for this extra moneythe trade gap, which is hundreds of billions of dollars.

The correct answer is that there are several things it can do, a couple of things it has done, and several things it may do to combat the recession.

First there are things China can do with the extra money. The first thing it can do, which The Bernanke Files has discussed at length, is use the extra money to pay its employees higher wages. The problem with this, of course, is that the USA buys goods from China because their wages are so low! Raising wages would hurt China's most important sector: manufacturing.

Second, China could use the extra money it receives to build up its infrastructure. Highways, ports, buildings, schools, regulators, boats, airports etc. could be built with the extra money. However, this raises two things: the demand for labor and (therefore) wages. Again this hurts their economy because China's economy is built on the assumption of low wages. Also, this kind of spending, when unwarranted, creates bubbles by producing things, like boats, that are not needed by the market participants.

Third, China can and does purchase American T-Bonds at an extroardinary rate. This serves three purposes: it keeps Chinese wages low, it diversifies China's government because the T-Bond is a very safe investment, and it gives American's more money and therefore higher wages. Higher wages and more money give American's more fuel to purchase Chinese goods! This full circle of US cash to China for goods, that same cash back to America so we can buy more goods is very important to the Chinese growth model. Actually, all high exporting countries (Germany, Brazil, India, Vietnam) follow this same model.

Finally, it can use this money to subsidize a certain sector of the economy. For example, China can lend the extra cash to very large manufacturing corporations to make sure they keep making STUFF that Americans buy. But what happens when Americans quit purchasing the STUFF, and China keeps making the STUFF?

It is also important to remember that China receives extra cash from another source: local Chinese citizens that want to SAVE money. Since China wants to stifle local Chinese citizens from buying too much (so that imports do not go too high and other reasons) they can either give the citizens high interest rates so that the Chinese have more incentive to save money, or they can ration goods (like USA did during WWII...hmm, we were the lending nation back then, think theres a correlation?), explicitly by direct rationing or implicitly by keeping wages low and credit card restrictions high.

So basically China has used its own citizen's money to, well, screw over most of the Chinese citizens. Of course, China does this because they believe that in the long run it will pay off.

The next economics riddle should be "So what happens when America goes into a recession and quits buying Chinese goods but China passes a huge stimulus bill and keeps making the goods anyways?" But, this will be such a depressing subject I will save Bernanke fans everywhere a lot of grief and just answer briefly: Nothing good.

Inflation at 0.0

The Consumer Price Index data that measures inflation was released today. Inflation is at 0.0% year over year.

Last year at this time inflation was peaking, so this months CPI data is being compared to a peak. Still, inflation hawks and anti-Fed fear mongerers have to be laughing at themselves. Inflation is not currently a problem and won't be for sometime, if at all.

There are two reasons for this. First, the Federal Reserve has very powerful tools to combat inflation. But, even if these are not enough, the Fed will most likely sacrifice low unemployment to maintain low inflation rates. What we need to be worried about is not inflation, but rather that the Fed has to back off of easy monetary policy before unemployment returns to acceptable levels.

A Whacky Few Days

A few days ago The Bernanke Files hypothesized that some important economic relationships were changing. For example, a few months ago the yields on T-Bonds went up when the market went up. This could be seen as a "flight to safety" relationship because when the markets went down investors became fearful and bought bonds.

But The Bernanke Files is hypothesizing that the motives behind movements will change as investors are driven less by fear and more by other market indicators. This change affects oil, the Dow, bonds, individual stocks and gold.

Today gives us empirical evidence that this trend may be swaying in the direction that The Bernanke Files has argued it will be going: the markets went up, but the interest rate WENT DOWN. This is opposite of what you would have expected a few months ago and supports The Bernanke Files hypothesis.

The Past Weeks Odd Movements

Since the recession began there have been certain up/down relationships between several markets. For example, when the Dow Jones went DOWN, the dollar usually went UP. When the Dow Jones went DOWN, crude oil went DOWN. When the dollar went UP, bond rates went DOWN. Most of these movements were explained by pointing out they are "protectionist plays." When the Dow Jones went down, fear made investors seek the safety of the dollar thus raising demand and therefore the value of the dollar.

But!, over the last two weeks these relationships seem to be changing. At the end of last week the Dow Jones skyrocketed up several hundred points. Instead of the dollar and oil decreasing and bond rates going down, the opposite happened. Crude oil has decreased slightly, the dollar has appreciated in value and bond rates have remained unchanged.

The Bernanke Files will be watching this turn of events very closely. While still in the early stages, these changes could signify growth, but also the emergence of inflation risks. The Bernanke Files will keep you updated on this trend as events unfold.

What to Look for This Week

The Bernanke Files is reporting from beautiful Detroit, Michigan. Well, we're assuming its beautiful- we're actually stuck in the Detroit airport for a 3 hour delay.

Having some time on a Sunday evening, we thought it would be a good opportunity to take a look at the upcoming week. First, we take a look at where the Asian markets are at. Currently they (the Nikkei) are up 24.0 points. Few Americans are aware that the Asian markets open up in Japan in the morning (local time). This means they are open at about 3:00 pm MST. This early look gives us a preliminary look at what investors may have on their mind. Because the Asian markets are open, American markets open futures trading for most of their markets as well. For example, crude oil, corn, wheat, the Dow Jones Industrial Average and many other markets are open at night. These are called the "night markets."

After taking a brief look at the Asian and night markets, we take a look at the economic calender. The economic calender provides investors with the most important events occuring in the markets this week. Good economic calenders, such as the one provided by Bloomberg, also give users other helpful information such as what the concensus is and a brief description of what each event means.

This week, an important and interesting release occuring is the International Trade report. This gives us the earliest data on what America's net import/exports are. the concensus for this month is that the trade gap will be $25 billion. This is way down from last year because wer are importing a lot less goods because of the recession.

Keep in mind that the markets always beg the question: If a butterfly flaps its wings in China, what will occur in New York. The markets are closely intertwined. As you may notice, on Monday there are a lot T-Bill auctions. These results will tell us how much it cost for the government to borrow money. But, as The Bernanke Files has pointed out, the auctions and the International Trade report are linked. Remember, if Americans import more than they export, the cash that was used to buy the imports had to come from somewhere. Of course, one of the main places the funds come from is from T-Bond sales. This is why international trade and T-Bill sales are linked. Since foreign Americans need LESS money to make up the difference between imports and exports, foriegn exporting countries need to loan us LESS money to make up the difference. Therefore, demand for T-Bill will go DOWN and prices will drop AND THE INTEREST RATE WILL GO UP. These complex relationships between different sets of data make the markets very difficult to study.

The Future for Interest Rates

While The Bernanke Files never "looks into its crystal ball" and speculates about the future, we would like to discuss what economics ripples might occur when the we exit the recession. More specifically, this entry examines the effects on interest rates.

Currently interest rates are very low. The Fed discount window is at .25%, and 10-Year Treasury Bonds yield 3.71%. This tells us several things, but probably the most important thing it tells us that investors are very wary of starting new ventures. Since the yield is 3.71%, we know that an investor believes he CANNOT MAKE MORE THAN 3.71% outside of buying T-Bonds. While in reality this is too simple (the low interest rate includes a very high premium for the extreme safety it offers), this is a good place to start.

When the economy begins to turn around, these same investors will want to be taking advantage of a strengthened economy. Unfortunately, their money will be tied up in the T-Bond they purchased for, lets say, 8 more years. They have two option: keep the low yielding bond, or they can sell the bond for cash. If the investor chooses the latter, supply of bonds will go up and the interest rate will go up also!! (Remember, if supply goes up, than price goes down and the interest rate goes up).

It is at this inflection point (the point at which almost everybody with a T-Bond realizes investing is better than holding a low interest rate bond) that we will have to worry about another slowdown in the market because INVESTMENT will be stifled by higher interest rates. In other words, there will be a small window that interest rates will move between (the window between a very low interest rate and an interest rate that stifles investment).

If Congress runs too much of a fiscal deficit and has to borrow too much money (thus selling bonds), the enormous dropping of T-Bonds into the markets will make interest rates rise out of the window pushing us back into a recession.

At this point, though, foreign countries that export goods (China, India, Germany), will see a drop in exports because the USA slips back into a recession. They will reduce their employees wages by taking profit and purchasing T-Bonds. This LOWERS the interest rate in America and, because their is so much cash going into America, credit becomes easy and a bubble is created.

Of course this is an oversimplified model, but it shows how complex of a job economists have. Remember, this is almost exactly what happened from the 2001 recession through to the 2008 recession. It is interesting that while most people blame the Federal Reserve for easy money, they are curiously and I believe rightfully absent from the model. Easy money came from Congress fiscal irresponsibility, not the Federal Reserve keeping the discount window interest rates too low for a couple of quarters.

An Economics Riddle

Here are a couple of economics riddles.

An American buys a product from Wal-Mart that was made in China. Wal-Mart charged the American $1. How much of the $1 do the Chinese actually get?



In an unspecified time period, American's buys $2000 of goods from China. In that same amount of time, China buys $500 of goods from America. Where does the difference of $1500 go?

Hint: The answers are in percents, eg: 10% goes to fixing Chinese manufacturing machines.

Get it straight, folks

As everyone knows, Chairman of the Federal Reserve Ben Bernanke can by re-appointed by the President to a 4 year term in January. As expected, the Fed-haters are making something out of nothing.

This week Bernanke went in front of a television audience and answered questions asked by the average joe off of the street. Bernanke announced at the beginning of his term that he would try to make the Fed more transparent and help the American people understand exactly what is going on in the economy.

Libertarians have perverted Bernanke's intentions... in the stupidest way possible. If your going to make a long rant about how bad Ben is, at least make it a logical argument. Look at what this blog has to say (http://blogs.reuters.com/james-pethokoukis/2009/07/27/candidate-bernanke-hits-the-campaign-trail/).

"If Ben Bernanke were running TV ads, taking polls and holding town hall-style meetings, it wouldn’t be any clearer that he’s conducting an explicit reelection campaign for another four-year term as Federal Reserve chairman come next January."

So this guy thinks Bernanke is trying to campaign to be re-appointed to the Fed. The last Chairman of the Federal Reserve remained Chairman for the most amount of time he could (14 years). Would it not therefore follow logic to say that Bernanke, a smart fellow, would take a play out of Greenspan's playbook and do the same things Greenspan did to be re-appointed.

But, and the anti-Fed author admits this in his article, Greenspan stayed as far away from the public as possible. So, by explaining things to the public, Bernanke is doing the opposite of what the last 14 year Chairman did to be re-appointed.

This is ridiculous. Clearly, if Bernanke's only goal is to be re-appointed, he would do what the last Chairman did to get re-appointed did. He isn't, so clearly there is another motive for why Bernanke is doing what he said. Anti-Fed idiots will say anything to get attention and to create suspiscion about the Fed.

This Weeks Auctions

Today marks the end of a record auctions week. The government auctioned over $205 Billion dollars of T-Bonds to private investors and foreign governments. By selling T-Bonds to the public the government is doing two things. First, it raises the supply of T-Bonds in circulation. Theoretically this would raise the interest rates. Second, by accepting cash from investors it reduces the amount of cash investors will have to invest with in the future. Combining the double whammy of rising interest rates and reduced cash for investment gives us a good picture of why governments don't like going into debt: they don't like stifling investment.

However, this weeks auctions, under the supervision of the Fed and the Treasury, yielded lower interest rates! This means that investors don't expect inflation to be an immenent problem. It also means that investors still have confidence in the US to pay back the bonds. This is a clear indicator that the Fed is doing a good job because inflation expectations are low while money is being printed to stimulate the economy.

Adversly, though, it means that there will be $205 Billion less for investors to invest with in the future. From an investor's standpoint, it also means that they believe that an investment will yield less than the meager 2-4% the bonds pay them in interest each year.

This weeks auctions show us that the Federal Reserve is doing a good job with what it has to work with. In a perfect world Congress would not be spending like they are currently doing and this would make the Fed's job of handling inflation expectations much simpler. The Bernanke Files is going on record and suggesting that Congress should begin reducing spending soon, and arguing that the Fed has been and will continue doing a good job keeping inflation low while stimulating the economy.

Reminder

Tomorrow, Friday the 30th of July, is the final day of the governments bond auctions. This week saw a record sale of treasuries auctioned to investors. Usually this steep increase in the supply of bonds would raise the interest rates. This would be bad because it stifles investment and borrowing. Also, higher interest rates signal the threat of impending inflation.

The Bernanke Files will do a full survey of this weeks auctions after the markets close tomorrow so that readers get a better understanding of what is happening in the credit markets right now.