Consumer Prices

For the greater part of human history, leaders who were in a position to exercise power were accountable for their actions. The problem we are faced with today is that our political and (frequently) business leaders are not being held responsible for their actions. Thomas Sowell sums it up well: "It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong." Fortunately, there is an institution that exercises control over the academics at the Fed; it is called the 'real' market economy... and it has badly humbled the professors at the Fed.

Since the global economic crisis began in 2008, Italy’s GDP has declined by about 8%, nearly a million workers have lost their jobs, and real wages have come under increasing pressure. The most striking aspect of Italy’s recent turmoil is what has not happened: citizens have not poured into the streets demanding reform. Indeed, throughout the crisis, Italian society has remained uncharacteristically stable. Japan’s experience – characterized by more than 20 years of economic stagnation – offers important lessons for crisis-stricken democratic countries with aging populations. During Japan’s “lost decades,” successive Japanese governments allowed public debt to skyrocket and refused to confront the economy’s deep-rooted problems, allowing sclerosis to take hold. In fact, Japan’s leaders had little incentive to pursue bold reform, because voters consistently failed to demand it. The question now is what kind of shock would be required to motivate Italians to demand similar action.

Deflation - A derangement of money or credit, a symptom of which is falling prices. Not to be confused with a benign, i.e., downward shift in the composite supply curve, a symptom of which is also falling prices. In a genuine deflation, banks stop lending. Prices tumble because overextended businesses and consumers confront the necessity of selling assets in order to raise cash. When prices fall because efficient producers are competing to deliver lower-priced goods and services to the marketplace, that is called “progress.”  In 2013, central bankers the world over define deflation as a fall in prices, no matter what the cause. Nowadays, to forestall what is popularly called deflation, the world’s monetary authorities are seemingly prepared to pull out every radical policy stop. Where it all ends is one of the great questions of contemporary finance.

Overnight trading started with Asian markets continuing where yesterday's S&P 500 fizzle ended, wishing Summers could withdraw from Fed running again, as both the Nikkei and SHCOMP were well lower by the close. Perhaps all the easy multiple-expanding, headline-driven money is made, or perhaps economic fundamentals will finally start having to justify a 17x multiple on the S&P (a good is good regime for those who may be too young, or old, to remember), but overnight US futures were dull, and no doubt anticipating today's start of the "Most important FOMC meeting ever", which concludes tomorrow with an announcement by the Fed of what and how much (if any) tapering it will commence with an eye toward halting QE next summer, although more realistically what will happen is an Untaper being announced before then. While the start of the FOMC meeting is the main event, today we get CPI, TIC flows and the NAHB housing market index. Today's POMO is another modest $1.25-$1.75 billion in the long-end sector.

A dispassionate discussion of the weekend events and a look at the week ahead.  

It seems the hopes and dreams of a Japanese public (and their illustrious leaders) is being dashed on the same rocks as the US worker. Amid surging input prices (thanks to a devalued currency) with consumer prices rising at the fastest rate since 2008, Bloomberg notes that Japanese salaries extended the longest slide since 2010 squeezing the consumer as the failure of demand pull inflation becomes more than real. Despite a stock market that is surging and politicians the world over proclaiming Japan's victory, "companies aren't confident enough on the sustainability of the economic recovery," instead cutting salaries (in an oh-so-American manner) to manage higher input costs. With a sales-tax increase on its way, the consumer faces even more pressure, "if wages don't improve much, it may pose a political risk" to Abe's administration.

“Indians want to maintain a store of value, so they go to gold.”

‘Gold is the last man standing as rupee fuels inflation’ was not published on Bloomberg.com but the story was published on Live Mint.

 What is happening in India is a prelude to what will be seen in other economies in the coming years as currencies depreciate.

Food Aid. A first world problem for many.

From goal-seeked GDP, manipulated inflation, liquidity-flow-exaggerated trade data, and hidden (and divergent) PMI details, the question of the unreliability of Chinese data is not a new one. However, anecdotes aside, a new study from Peking University finds, conservatively, correcting for housing price inflation in the Chinese CPI data adds approximately 1% to annual consumer price inflation in China, reducing real GDP by 8-12% or more than $1 trillion.

The middle of the month brings a mixture of second-tier macro numbers punctuated by the market-moving (and Taper-cementing) retail sales report. We get IP, CPI and PPI from the US this coming week. In terms of hard activity numbers, US retail sales on Tuesday will be the highlight which as a reminder is, in addition to Jackson Hole, seen as one of two key pre-Taper catalysts to keep an eye on. Outside the US, the key data will be the quarterly publication of German, French and Eurozone GDP, as well as Japanese GDP, which has already been released (weaker real growth, higher inflation). The second week of the month also tends to show the first survey results with the Phily Fed and Empire surveys on Thursday. In Germany the ZEW will come on Tuesday. Finally, from an FX point of view, we will be focused on balance of payments related data, with the trade balance in India and TIC data in the US. After a few very weak TIC releases in recent months we would expect more evidence of weak capital inflows into the US.

The Chinese demand for gold essentially comes from three segments: (1) the People’s Bank of China; (2); the banking sector; and (3) Chinese citizens. We can count on the Chinese central bank to pursue the same steady course they have been pursuing for a while: buying additional gunpowder by increasing their gold reserves. More importantly, it is very likely that the current forced deleveraging will be accompanied by, for instance, a significant cut in interest rates or a lowering of the reserve requirements to offer the banking sector a helping hand (as the PBOC appears to be folding a little on its hard stance). This could have a major impact on gold. We’ll see why by observing that the bulk of Chinese gold demand comes from its third source: Chinese citizens. China has one of the world's highest saving rates, and the public faces few investment options. With negative real interest rates, in case the PBoC does lower rates to support the banking system, gold seems to be an opportune alternative.

So the second and third largest economies in the world are in collapse with stock market crashes. What are the odds the world will pull through this?

For the second consecutive day futures have drifted lower following a drubbing in the Nikkei which was down nearly 3% to just above 14K (time to start talking about the failure of Abenomics again despite National CPI posting the first positive print of 0.2% in forever and rising at the fastest pace in 5 years) and the Shanghai Composite which dropped to just above 2000 once again, after PBOC governor Zhou saying that China has big economic downward pressure and further reiterated prudent monetary policy will be pursued. This is despite Hilsenrath's latest puff piece which pushed the market into the green in yesterday's last hour of trading and despite initial optimism which saw stocks open higher following forecast-beating EU earnings gradually easing and heading into the North American open stocks are now little changed. It may be up to the WSJ mouhtpiece to provide today's 3pm catalyst to BTFATH, or else it will be up to the circular and HFT-early released UMichigan confidence index to surge/plunge in order to push stocks on any red flashing news is good news.

Global conditions in early 1928 were oddly similar to today (Benjamin Strong puzzling over a strange brew of rising stock prices, uneven economic recovery, suspect banking practices and unusual strains in Europe’s monetary system), but skewed in a direction that would cause our current policymakers to apply even stronger stimulus than we’ve seen in 2013. The analogy suggests to us that today’s Fed is threatening mistakes that aren’t unlike those of the 1920s Fed. But what about the stock market? Unfortunately, a few market characteristics fit the late 1920s timeline pretty well... There can be little doubt that today’s Fed-fueled asset price rallies merely bring future price appreciation forward to the present. Asset prices eventually return to fundamental values, and as they do the Fed’s cherished wealth effects work in reverse. This is another risk that should be considered when you decide whether to take Bernanke’s bait and “reach for yield” in stocks and other risky assets.

Dispassionate review of some of next weeks important developments.