Tuesday, September 25, 2012 - Fed Good at Growing Inequality

Fed Good at Growing Inequality

by Sinclair Noe

DOW – 101 = 13,457
SPX – 15 = 1441
NAS – 43 = 3117
10 YR YLD -.04 = 1.68%
OIL - .51 = 90.86
GOLD – 3.90 = 1761.60
SILV - .23 = 33.84
PLAT + 8.00 = 1634.00

Let’s start with a few economic reports. Case Shiller’s Index of existing home sales posted a 1.6% increase in July; all 20 cities in the index saw housing prices rise; it’s the fourth month of price increases, and the past 12 months are now showing increases. This is very positive news for housing. Pricesin Phoenix gained 2.2% to take the year-on-year increase to 16.6%, by far the strongest advance of any major metropolitan area. Los Angeles saw a 1.3% gain, and the year-over-year comparison has now turned positive by 0.4%.

The consumer-confidence index increased to 70.3 in September, the highest level since February. Generally when the economy is growing at a good clip, confidence readings reach at least 90. September expectations increased for employment and business conditions, while consumers’ views on the present situation also rose. One of the big factors affecting the optimistic outlook is the turn in the housing market.  In August, the dividend-reinvested S&P 500 was up some 18% year-on-year. The combination of positive returns on stocks and real estate hasn’t been this good since 2006. Any economic gains are still fragile but you take whatever positives you can find. Both consumer-confidence measures, the one conducted by the University of Michigan and the one done by the Conference Board, showed big pops in September.

Optimism is a marvelous thing but every party has a pooper, and today, the party on Wall Street fizzled when  Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank's latest round of monetary easing was unlikely to help growth. Earlier this month, the Fed announced it would continue with Operation Twist, and they added a plan to buy $40 billion a month in mortgage backed securities; the plan was open-ended; the Fed would just keep buying until the employment situation improved.  But Plosser doesn’t think it will work; he says: “We are unlikely to see much benefit to growth or to employment from further asset purchases." 

Plosser’s comments weren’t a big surprise; he is considered hawkish among the Fed Presidents. Other Fed leaders have announced their support for QE to infinity and beyond. Still, Plosser drew some of the blame for the stock market’s sour mood this afternoon.

Central banks in the US, Europe and Japan may have come forward with stimulus measures in recent weeks to try to stimulate the global economy but not every country is cranking up the printing press. South Korea is buying gold; they added about 70 metric tons of gold to their reserves. Russia also added to reserves, but not as much as the Koreans. So the trend of central banks beefing up their gold reserves is alive and well.

Inflation is the most talked about risk of all this central bank money printing but there is still a lot of deleveraging in the US economy.  Bernanke is probably right to discount inflation as a short term danger. Meanwhile, we’ve heard nothing from the Federal Reserve or its assorted hawk and dove presidents about the impact of the Fed’s sustained easy-money policy on economic inequality. The Organization for Economic Cooperation and Development, the OECD says income inequality has been increasing in the US, to the point where the top 10 percent of our population earns 14 times more than the bottom decile; the OECD average ratio is 9 to 1.

You can’t blame the Fed. Well, you can blame them but not for everything. The world has changed, and you have to consider globablization, technological change, education, demographic patterns, and fiscal policy has been horrific in this country for at least the past 30 years, maybe forty.  Maybe the Fed cranking up the printing press will help create a few jobs, which might help the inequality problem. Workers pulling in a wage are doing better than workers pulling in an unemployment check or nothing at all.  The crazy part is how the Fed’s plan may or may not work. Bernanke’s plan is to push down interest rates across the board which should increase the value of assets such as stocks and real estate; then the people that own stocks and real estate will feel wealthier and they will be more likely to go out and spend money or borrow money to spend; rising demand will force businesses to hire new workers. We know that people are feeling more confident but that might not equate to feeling wealthier, much less result in actual spending 

Individual participation in equities has been on the decline for 10 years; institutional investors and high frequency traders dominate the stock markets. Families in the lowest 20 percent of the income distribution scale spend more than a third of their income on food. Households in the bottom fifth spend 10% of their annual income on gas, vs. 2.2% for the top quintile. Yesterday, Goldman Sachs predicted commodity prices will rise 18.2%, in large part because of QE. Ironic, isn’t it?

The Dallas Federal Reserve is a strange branch location; they’ve issued papers about splitting up the too big to fail banks. Now they’ve issued a research paper that examines the central banks role in increasing inequality. The paper says the Fed’s accommodative policy and bailouts have supported the financial sector and the result is the rich got richer and the poor got poorer, and the result is the US has more inequality than any other developed nation. Bernanke says he wants to help people get jobs, but the tools he has used over the years and continues to use today have only resulted in a lopsided economy.

Part of the blame has to fall at the feet of Congress. Bernanke is giving Congress at least a little cover for continuing to do nothing. In pop psychology that's known as being an enabler. Has he even considered the merits of holding Congress's feet to the fire by declining to perpetuate his policy of centrally-planned subsidized money and the accompanying systematic understating of risk?

What else is going on in the world? The Greek government is resisting a push by yhe IMF to impose additional austerity measures. The Greek people are increasingly angry over the prospect that public salaries and pensions will be cut again in a last-ditch bid to secure a new loan installment of $40 billion from Greece’s creditors.

Meanwhile, the Portuguese people have put up with one draconian package after another – with longer working hours, pay cuts, tax rises, an erosion of pensions, and the result is that the economy has contracted by a little over 10%.They have protested peacefully, but they finally said enough is enough and they have killed a plan to raise social security taxes. Portugal cannot recover under the policies in place. The government is destroying the Portuguese economy for no useful purpose. It is pain without gain.

As Spain tries desperately to meet its budget targets, it has been forced to embark on the same path as Greece, introducing one austerity measure after another, cutting jobs, salaries, pensions and benefits, even as the economy continues to shrink.  Once again, Spanish protestors took to the streets and encircled the main parliament building. Parliament took on the appearance of a heavily guarded fortress as about 1,400 police officers ringed the building to keep back demonstrators. The organizers of the latest protest said in a statement that they had no plans to try to occupy Parliament, but instead wanted to surround the building to show that “democracy has been kidnapped” and needs to be saved from the hands of inept Spanish politicians. Spain must still decide whether they want to accept the IMF bailout and its attendant demands, which can never be met.

The Bank for International Settlements says  German lenders have the highest exposure in Europe to Spain, at $139.9 billion, of which $45.9 billion alone is exposure to banks.