1. Consumers Saving More-But Is that to Measured in Months or Years?: In 2005, Americans borrowed 750 billion against the value of their homes and spent two-thirds of it. Growth was fueled by this expansion of credit that is not likely to return until the lessons learned from such carelessness are forgotten by most, as will certainly happen. Now, instead of spending vast sums of borrowed money, Americans are actually saving part of their paycheck, with the personal savings rate increasing to 5.7% in April, the highest rate since February 1995. BEA : News Release: Personal Income and Outlays, April 2009
Many will cite that figure, along with the oft quoted refrain that consumer spending represents 2/3rds of GDP, to support a pessimistic outlook for the economy. How can there be growth with the consumer saving rather than spending like a hoard of drunken sailors. That is no longer an alternative. Economic growth fueled by using a home as an ATM card is simply not going to happen for years to come. I would not, however, assume that the American consumer will turn to thrift for years to come either. The current frugality will most likely not be the new normal but a temporary hiatus between extravagant spending beyond their means to a more careful and responsible spending pattern that would not be fairly characterized by most observers as spendthrift. So, I would postulate now that the American consumer is merely in hibernation waiting for winter conditions to thaw, when the past will once again become a faint memory in the remote control nation.
2. Why Does Volcker Predict Low Inflation for "Some Time To Come"?: It is always easy to find a prominent economist on different sides of the same issue. Volcker may very well be the most prominent economist who has stated that inflation will not be a problem for "some time to come", a phrase that he used in a recent speech in China. Volcker has a lot more gravitas with me than something like Art Laffer who is predicting much higher rates of inflation over the next four or five years Inflation, or the panelists in the Barron's Roundtable who express views similar to Laffer. On this matter, I would go with Laffer, provided I could start the time period in about a year from now for significant inflationary pressures showing up, but I do not have his certainty.
One restraint on inflationary pressure building up now is labor's lack of bargaining power for wage increases. With unemployment approaching 10%, workers are more concerned about keeping their job than obtaining a raise. Wage inflation is one of the main drivers of inflation. Then, there is a lot of excess capacity worldwide, and economists like Volcker probably have difficulty predicting worrisome inflation when both demand and wage increases are subdued, with significant amounts of production capacity remaining idle. They may be right for the next year, with occasional bumps in the CPI caused by commodity price increases, but ultimately their forecast is dependent on a slow recovery and unemployment remaining high for a least a couple of years.
The current FED forecast is consistent with Volcker's tough slog thesis, with the FED predicting unemployment of 9 to 9 1/2 per cent in 2010 (item #2: Morning Potpourri: March 21, 2009/Sold GSG)
If worldwide GDP remains sluggish in 2010, with high rates of unemployment, then a low inflation forecast would be reasonable, though far from certain, between now and the end of 2010, notwithstanding the worldwide fiscal and monetary stimulus but 2011 would be a different matter, when the FED is predicting an acceleration of growth.
But what if growth next year in the U.S. is 3 1/2% to 4 1/2% with unemployment falling to 5 % by the 4th quarter of 2010 and topping at less than 10% this quarter, a plausible forecast, and GDP growth in China and other important emerging markets hits a double digit stride later in this year. Then, I would wonder what Volcker would say about his inflation forecast then, particularly if commodity prices continue their upward trajectory. I suspect that the U.S. economy is going to recover quicker than currently predicted, and the FED will be late in draining the excess money supply.
3. Fool's Gold by Gillian Tett: I read a review of this recently released book in the NYT this Sunday, and read some of it while lounging at the local Borders bookstore NYTimes.com Interview It is about the small coterie of youngsters at J P Morgan who first industrialized the financial instruments that almost destroyed the world's financial system. The book starts out with a description of a fraternity like event at a Florida resort, straight out of the movie Animal House, where the youngsters brainstormed while engaged in imbibing libations liberally under the guidance of their 35 year old leader. One thing that struck me after reading the first fifty pages is that the youngsters were really not innovative at all. The entire concept of credit default insurance is just an extension of a traditional insurance arrangement to a debt instrument, without following any of the rules underlying traditional insurance contracts including oversight by a regulatory authority, setting aside reserves and other protections. In fairness to Morgan, the original use of these instruments, as applied to corporate loans issued by seasoned borrowers, would not have led to a credit crisis. The problem came later, as other investment banks started to apply those financial instruments in increasingly bizarre ways to expand the extension of credit in the home mortgage market.
Ultimately, the financial products, which were created as a means to control risks, became the means for risks to be created and then amplified, by fostering and encouraging irresponsible risk taking and credit extension particularly in mortgage originations and securitizations.
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