Times Have Changed at the Fed

by: Bernard Thomas

Thursday brought us more disappointing Jobless Claims data. Initial Jobless came in at 445,000 versus a street consensus of 455,000. The prior data was revised upward from 453,000 to 456,000. Continuing claims came in at 4,462,000 versus a street consensus of 4,450,000 and a prior revised 4,510,000 (up from 4,457,000). In spite of what some pundits espoused yesterday morning, these are troubling numbers. It is true that initial claims dropped a bit, but claims over 400,000 is troubling. Even more troubling is that fact that continuing jobless claims and the extended benefits roll remain stubbornly high.

In fact, the number of Americans on extended benefits increased by 257,000 to 5.14 million. This brings the total number of Americans receiving unemployment benefits to 9,602.000. The fact that businesses are slowing the pace of hiring does not cut it. Some economists believe it could take years to replace the approximately 8 million jobs lost since the recession began. The problem is that at the same time, the U.S. population will increase. This is like a cat chasing a string. Every time we seem to make progress the goal remains seemingly just out of reach.

What does this mean for today's employment data? It is obvious that recent data has not been encouraging, but it may not translate directly into the Nonfarm Payrolls and Unemployment Rate data. Such data is subject to various quirks via the way the data is gathered and by their formulas. Remember a few years ago when the Nonfarm Payrolls number undercounted approximately 800,000 jobs over the course of a year or so? The consensus estimate for NFP is 0. However, whether the number comes in -50k or +50k, it matters little as either would be disappointing.

After reading Thursday's Wall Street Journal, I felt as though I was in an episode of the "Twilight Zone". An article on page A8 states that the Fed is considering higher inflation as a way to stimulate spending and growth. The thinking is that if inflation is allowed to run faster than the Fed's alleged target of about 2.00% (let's say to 4.00%), consumers would be further disincentivized to save and would spend more aggressively. What is happening here? Is Bernanke the anti-Volcker? Maybe, maybe not. The problem is that Bernanke realizes just how impaired the U.S. economy is. He, along with other policy makers are trying to avoid a deflationary correction of asset prices, home prices in particular. That could be an exercise in futility.

Thursday morning on CNBC, Pimco's Mohammed El-Ehrian stated that part of the problem is that Americans and policy makers want it all. They want banks to lend, but de-risk. They want consumers to spend, but not severely deleverage while strengthening household balance sheets. It cannot be done. Something has to give. A few years ago it was not uncommon for home values to double in a year or two. Did anyone with a shred of common sense really believe that was sustainable? No, but common sense was eschewed in favor of optimism and models. Reality can be ignored only so long. It is time to pay the piper and he is not cheap.

Former Wall Street Junk Bond "Star" Michael Milken wrote in yesterday's Journal his remedies for what ails the U.S. economy. Especially helpful and insightful is his analysis of the housing debacle. He states:

My early academic research showed that investments in loans against real estate were worse investments than loans to businesses. Collateralized loans to U.S. companies, which create nearly all American jobs, have stood the test of time. Meanwhile, investors have suffered some $1 trillion in losses on supposedly safe mortgage-backed assets. Consider how many more jobs small businesses would have created if they'd enjoyed the same terms we gave homeowners-easy access to 30-year, government-guaranteed loans at near-prime rates with no prepayment penalties. Those terms encouraged larger houses-the average size doubled in a generation to 2,500 square feet, even as family size shrank. This required more land farther from cities, and we bought bigger cars for longer, energy-wasting commutes.

He continues:

American policy makers got it backwards: In the long run, jobs support housing, not the other way around.

I believe Mr. Milken is spot on. Relying on ever-higher home prices, ever more new construction and ever easier access to credit (and the resulting over-leveraged consumer) is a recipe for disaster, as we have recently seen.

There has been much China bashing emanating form Capitol Hill and from Europe. China is being roundly criticized for undervaluing its currency. China snapped back that letting its currency appreciate by the 20%+ that many of its critics are calling for would result in economic hardship for China. For years we have stated that China will do what is right for China. However, the U.S. will do what is right for the U.S. All Fed Chairman Ben Bernanke is doing is to devalue the dollar. His problem is that he cannot devalue the dollar versus the yuan as China has its currency pegged to the dollar. Japan, South Korea and Brazil have all taken action to halt or moderate the rise of their currencies. There is speculation that the EU and the UK may not be far behind.

Why would Mr. Bernanke risk a currency war which could strain international trade relations? Because he realizes just how bad the economy is. He cares little about foreign economies. He responsibilities lie between the Atlantic and Pacific oceans. Just as Chinese officials will do what the believe to be right for China, Fed officials will do what the believe is right for America.

We are in a race to the bottom in which global economies are trying to grab the largest possible slice of a shrinking pie. V-shaped recovery? We don't see it, at least not for consumers. Since consumers ARE America, a recovery which leaves them behind is no recovery at all.

Disclosure: No positions