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July 1, 2005
To no one’s surprise, the Fed raised the cost of overnight money to 3.25% on Thursday. The 10-year T-note and fixed-rate mortgages then improved slightly, to 3.92% and 5.50% respectively.
Whether in a delayed reaction to the Fed, or strength in today’s release of the June purchasing managers’ index, the 10-year is now 4.04%, taking mortgages up.
I think it’s the Fed. Its post-meeting statement was merciless: “...Even after this action, the stance of monetary policy remains accommodative... The expansion remains firm.” Mr. Greenspan still thinks the economy is fine, will go to 3.50% on August 9, and gave not the slightest hint that neutral and a pause may be nearby.
Greenspan’s Conundrum -- why long-term yields are still so low -- is now Greenspan’s Standoff. A flat yield curve is a traditional warning to the Fed that it is too tight, but the Chairman insists that the standard explanations do not apply. Further, he says he intends only a neutral policy to remove “imbalances.”
He will not say what those imbalances are. The Fed’s job is inflation-fighting, and there isn’t any to worry about. The real conundrum: what would make him hammer at the cost of money during a visible slowdown in the global economy?
I am not sure how today’s economy works, but I have argued for several years that whatever it is, today’s economy is not the one we grew up with, 1945-2000. All of us tend to focus on preparing to re-fight the last war. Economists have magnificent models for predicting the next expansion-inflation-recession cycle, and the Navy is superbly equipped to fight a carrier war in the Pacific.
In January, the Wall Street Journal asked 56 economists to predict where the 10-year T-note yield would be on June 1st: one got right the first digit. Thirty-four guessed 4.50% to 5.00%, sixteen above 5.00%. I would mention the name of the guy who got the “3” right, but he missed economic growth by one-third.
At $60 oil, and still no inflation, we’ve got to look for another war to fight, the one Mr. Greenspan is fighting. He won’t talk, but try this: consumer-price inflation died at the hands of a determined Fed (it took 20 years...), IT-generated cost-compression, and the entry of China and India as undercut-cost manufacturers.
Consumer-price inflation died so hard that the Fed had to intercept the possibility of deflation, which it did with “helicopter money” (the term Fedologists use for the Fed’s last resort: criss-cross the country in choppers, tossing bales of hundreds into the blade-wash). Most of that money is still out there, blowing around.
Fancy answers to Greenspan’s Conundrum abound, but the simplest one looks better all the time: the helicopter money can’t cause consumer-price inflation because there’s too much production capacity available, and can’t cause wage inflation because there are too many workers available. However, the money can begin to chase things that are in short supply, and then we can get inflation very different from the last war. Asset inflation. Serial bubbles, not just stocks ’99-‘00.
Real estate is in short supply. I still don’t see a housing bubble, but if prices get too high, the market will become accident-prone. Some people say commodities are in short supply, but most aren’t, as supply quickly increases in response to higher prices (exceptions: oil and gold, both way up). Stocks are in short supply; good ideas for businesses don’t come along every day. Bonds and mortgages are rarely in short supply; bid interest rates down far enough and you find more borrowers.
Mr. Greenspan will keep going until he thinks short-term rates are high enough to sponge helicopter money back into savings, where it belongs. Real estate and stocks look pricey but not crazy, bonds seem fairly priced to consumer inflation, commodities are calming down, and... you know, in The Man’s last act in the chair, we might just get out of this with a whole hide. But, at 4.00% or higher.
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