Published on 'The Small Cap Investor. com" website, January 4, 2010.
While walking to the post office last summer, I stopped into a vintage mid-century furniture store named Revival. I wandered into the store that day because I recognized the furniture from my childhood. They say, you can't go back, but for the moment, I proved the cynics wrong as I stepped into this kitschy store, and stepped back in time. My elation was short-lived however, as I realized the century being referred to was the twentieth, and that mid-century was in reference to the 1950's, the decade in which I was born. Newly classified a mid-century antique, I immediately wondered if I should be calling a cab, instead of making the round trip home on my vintage legs. I chose to gut-it-out though, and walk home, affording myself the time to contemplate a much simpler era.
It was a time when we kept our money in savings accounts, and kept tabs of our funds in passbooks. Americans drove American automobiles, women stayed home and raised the kids, and "Father Knew Best". Ozzie and Harriet, Andy Griffith, and Dick Van Dyke were not only the most popular shows on television, but icons of pop culture and symbols of the American dream. Kids played sports, (not video games) - people typed on typewriters, and everybody read the newspaper. However, the fifties' ideals were contradicted by a clear social and political dichotomy. Racial discrimination pervaded daily life, there was little concern for the environment, and the government adhered to a lunatic doctrinal framework which was the basis for a Cold War, that would soon bring our country to the brink of nuclear disaster.
While the Fed''s monetary policies of the 1950's are often criticized, the decade's economic performance contradicts the critics claims. Inflation, measured using the GDP deflator, averaged under 2.0 percent per year between 1952 and 1960, and it never went above 3.3 percent in a single year. Real GDP over the same period grew at an average rate of 2.9 percent per year, and the unemployment rate averaged 4.7 percent. While there were two recessions during this decade, the one in 1954 was exceedingly mild, and the one in 1958 was sharp but very brief. The Fed of the 1950's was obviously just as concerned, as today's Fed, when it came to controlling inflation, and the economic results of their actions, suggests they had figured out the essence of sensible policy. However, economic, social, and demographic factors were different in the 50's; people were big savers, frugal spenders, and were cautious about purchasing items on credit, even though credit was easily available. Oil was still cheap and abundant, and was produced domestically, not imported. Interest rates were relatively low, there was a trade surplus, and the dollar reigned supreme. It was the beginning of the baby boom, and it was the time when women began to enter the workforce.
There have been some encouraging trends since the 1950's; a heightened concern for civil and human rights, including the rights of minorities and women, and a growing concern for the welfare of the environment. Technological innovation dramatically increased our access to information and enhanced our lives, but concurrently created a digital divide. Our economy experienced tremendous growth and was integrated into the global economy, but progress inadvertently introduced problems that affected economic stability and quality of life. With the gross national debt now over 12 trillion dollars, a myopic federal government continues to implement short term solutions at the expense of future growth. Ironically, the same policy makers that originally created these problems, have often lacked either the political will or expertise to correct their mistakes. The Fed's treatment for our economic ills, has always been to lower interest rates and boost liquidity, a cure that may be far worse than the disease itself. As a result, the American consumer's wealth has been destroyed because of the record drop in home prices and decimated retirement plans. Unemployment is still above 10%, and home foreclosures and bankruptcies are setting records, as over-leveraged consumers are increasingly squeezed by unaffordable home-equity loan payments, and rising food and energy costs. Even for those who qualify, credit is unavailable, and a declining dollar is reducing the consumer's buying power and causing a shift to other currencies for foreign trade.
In an effort to scale back the vast amounts of money it pumped into the economy, the Fed is beginning to drain reserves by conducting reverse repos, proposed a plan for term deposits, and is terminating it's security purchase program at the end of March. While it is argued the amount of excess capacity and structurally high unemployment in the economy will continue to keep inflation at bay, rising commodity and oil prices, and rising treasury yields indicates otherwise. The Fed is planning on auctioning $2.5 trillion in treasuries in 2010, (to fund continued deficit spending) and is extending the average duration of its debt from 48 to 72 months, essentially setting themselves up an inflationary default on those obligations. The break evens on the 10 year tips/notes is up a 150 basis points from a year ago to 250bp, and the yield curve in nominal bonds has steepened to record levels, suggesting that inflation is being priced into the market.
Fiscal stimulus from the bailout, and artificially low interest rates both enabled and forced capital to flow toward riskier assets. With risk mitigated by an acknowledged Fed put and a low yield environment that offered minimal returns on safer assets, the market responded with a 66% rally in the SPX off the March lows. In the past, such low interest rate/loose monetary conditions has resulted in bubbles due to the speculative excesses in riskier assets. The current rally is the immediate corollary of such action, and while significantly overvalued and overextended, could extend even further as momentum traders and retail investors chase the market. Shell shocked from the recent collapse of the equities market, the retail investor is just starting to leave the safety of fixed income funds and cash, and is slowly returning to the stock market. Paradigmatically, the market is now setting up for potential price exhaustion, and the bursting of this de facto equities bubble.
The Fed's over-reactive policies date back to the borrow-and-spend Regan years, through the doubling-of-our-debt Bush years, to what will undoubtedly be the redoubling-of-our-debt Obama years. It strikes me as ironic then, that the furniture store I walked into that day, was named "Revival": a new presentation of an existing theme. The Fed once again expects the American consumer to re-inflate the economy, but the consumer is already over-borrowed, over-spent, and broke. Besides, the banks aren't lending money; instead they continue to hoard cash and play the carry trade, borrowing money for next to nothing and investing it in government bonds yielding 3.8%-4.6%. So while the past abuses to the financial system, (culminating in the bursting of the sub-prime bubble), has structurally changed the global economic system, dealing with these problems have remained the same. We all understand, you can't go back, but we should also realize...the more things change, the more they stay the same.
While walking to the post office last summer, I stopped into a vintage mid-century furniture store named Revival. I wandered into the store that day because I recognized the furniture from my childhood. They say, you can't go back, but for the moment, I proved the cynics wrong as I stepped into this kitschy store, and stepped back in time. My elation was short-lived however, as I realized the century being referred to was the twentieth, and that mid-century was in reference to the 1950's, the decade in which I was born. Newly classified a mid-century antique, I immediately wondered if I should be calling a cab, instead of making the round trip home on my vintage legs. I chose to gut-it-out though, and walk home, affording myself the time to contemplate a much simpler era.
It was a time when we kept our money in savings accounts, and kept tabs of our funds in passbooks. Americans drove American automobiles, women stayed home and raised the kids, and "Father Knew Best". Ozzie and Harriet, Andy Griffith, and Dick Van Dyke were not only the most popular shows on television, but icons of pop culture and symbols of the American dream. Kids played sports, (not video games) - people typed on typewriters, and everybody read the newspaper. However, the fifties' ideals were contradicted by a clear social and political dichotomy. Racial discrimination pervaded daily life, there was little concern for the environment, and the government adhered to a lunatic doctrinal framework which was the basis for a Cold War, that would soon bring our country to the brink of nuclear disaster.
While the Fed''s monetary policies of the 1950's are often criticized, the decade's economic performance contradicts the critics claims. Inflation, measured using the GDP deflator, averaged under 2.0 percent per year between 1952 and 1960, and it never went above 3.3 percent in a single year. Real GDP over the same period grew at an average rate of 2.9 percent per year, and the unemployment rate averaged 4.7 percent. While there were two recessions during this decade, the one in 1954 was exceedingly mild, and the one in 1958 was sharp but very brief. The Fed of the 1950's was obviously just as concerned, as today's Fed, when it came to controlling inflation, and the economic results of their actions, suggests they had figured out the essence of sensible policy. However, economic, social, and demographic factors were different in the 50's; people were big savers, frugal spenders, and were cautious about purchasing items on credit, even though credit was easily available. Oil was still cheap and abundant, and was produced domestically, not imported. Interest rates were relatively low, there was a trade surplus, and the dollar reigned supreme. It was the beginning of the baby boom, and it was the time when women began to enter the workforce.
There have been some encouraging trends since the 1950's; a heightened concern for civil and human rights, including the rights of minorities and women, and a growing concern for the welfare of the environment. Technological innovation dramatically increased our access to information and enhanced our lives, but concurrently created a digital divide. Our economy experienced tremendous growth and was integrated into the global economy, but progress inadvertently introduced problems that affected economic stability and quality of life. With the gross national debt now over 12 trillion dollars, a myopic federal government continues to implement short term solutions at the expense of future growth. Ironically, the same policy makers that originally created these problems, have often lacked either the political will or expertise to correct their mistakes. The Fed's treatment for our economic ills, has always been to lower interest rates and boost liquidity, a cure that may be far worse than the disease itself. As a result, the American consumer's wealth has been destroyed because of the record drop in home prices and decimated retirement plans. Unemployment is still above 10%, and home foreclosures and bankruptcies are setting records, as over-leveraged consumers are increasingly squeezed by unaffordable home-equity loan payments, and rising food and energy costs. Even for those who qualify, credit is unavailable, and a declining dollar is reducing the consumer's buying power and causing a shift to other currencies for foreign trade.
In an effort to scale back the vast amounts of money it pumped into the economy, the Fed is beginning to drain reserves by conducting reverse repos, proposed a plan for term deposits, and is terminating it's security purchase program at the end of March. While it is argued the amount of excess capacity and structurally high unemployment in the economy will continue to keep inflation at bay, rising commodity and oil prices, and rising treasury yields indicates otherwise. The Fed is planning on auctioning $2.5 trillion in treasuries in 2010, (to fund continued deficit spending) and is extending the average duration of its debt from 48 to 72 months, essentially setting themselves up an inflationary default on those obligations. The break evens on the 10 year tips/notes is up a 150 basis points from a year ago to 250bp, and the yield curve in nominal bonds has steepened to record levels, suggesting that inflation is being priced into the market.
Fiscal stimulus from the bailout, and artificially low interest rates both enabled and forced capital to flow toward riskier assets. With risk mitigated by an acknowledged Fed put and a low yield environment that offered minimal returns on safer assets, the market responded with a 66% rally in the SPX off the March lows. In the past, such low interest rate/loose monetary conditions has resulted in bubbles due to the speculative excesses in riskier assets. The current rally is the immediate corollary of such action, and while significantly overvalued and overextended, could extend even further as momentum traders and retail investors chase the market. Shell shocked from the recent collapse of the equities market, the retail investor is just starting to leave the safety of fixed income funds and cash, and is slowly returning to the stock market. Paradigmatically, the market is now setting up for potential price exhaustion, and the bursting of this de facto equities bubble.
The Fed's over-reactive policies date back to the borrow-and-spend Regan years, through the doubling-of-our-debt Bush years, to what will undoubtedly be the redoubling-of-our-debt Obama years. It strikes me as ironic then, that the furniture store I walked into that day, was named "Revival": a new presentation of an existing theme. The Fed once again expects the American consumer to re-inflate the economy, but the consumer is already over-borrowed, over-spent, and broke. Besides, the banks aren't lending money; instead they continue to hoard cash and play the carry trade, borrowing money for next to nothing and investing it in government bonds yielding 3.8%-4.6%. So while the past abuses to the financial system, (culminating in the bursting of the sub-prime bubble), has structurally changed the global economic system, dealing with these problems have remained the same. We all understand, you can't go back, but we should also realize...the more things change, the more they stay the same.
