Thursday, January 09, 2014 - A World Of Central Bankers

A World Of Central Bankers

by Sinclair Noe

DOW – 17 = 16,444
SPX + 0.64 = 1838
NAS – 9 = 4156
10 YR YLD - .03 = 2.96%
OIL - .67 = 91.66
GOLD + 1.80 = 1228.70
SILV + .02 = 19.65

If it's not one central bank, it's another. Today the European Central Bank and the Bank of England met to determine monetary policy. Back in November, the ECB cut interest rates to 0.25%, so there were no expectations of further rate cuts in today's meeting. In Britain, which is outside the euro zone, the Bank of England left its benchmark interest rate unchanged at a record low of 0.5 percent.

As the US Federal Reserve has been creating new dollars at the rate of $85 billion a month under Quantitative Easing, the Fed's balance sheet has been growing, even as the ECB's balance sheet has been shrinking. And even though the Fed announced it would scale back those purchases by $10 billion a month, that just means the Fed balance sheet will continue growing, just not as fast. Or the bottom line; the Fed is creating money and the ECB is not.

Today, Mario Draghi, the president of the ECB said he wanted to “strongly emphasize” his earlier promise to keep monetary policy easy for as long as necessary. And Draghi said the ECB was “ready to consider all available instruments” to address either further weakness in consumer prices or increases in short-term money market rates that could put stress on banks. He did not, though, specify what tools he would use. The fear in Europe is that a nascent recovery could sputter and that low inflation (0.8% in December) could turn into deflation.

When asked if the euro crisis was over, Draghi said, “The recovery is there, but it’s fragile,” and it was too soon to declare victory. Even that might be a stretch. The unemployment problem for much of the euro-zone remains lousy; stuck at 12.1% for the past 9 months, and in some areas, youth unemployment is still around 50%, very dangerous levels. The problem for the ECB is essentially the same problem the Fed faces – how to improve aggregate demand. The ECB has been offering cheap money to the euro banks but the credit isn't getting through to companies and households. Lending to small businesses in the euro zone shrank 3.9% in November from a year ago, the biggest decline recorded by the ECB.

And with the Fed taper ready to kick in, the hope is that other countries and other central banks will pick up some slack in the world economy. Draghi has promised to do whatever it takes, and today he reiterated that promise, but that has been the promise for the past couple of years, and a couple of years can easily turn into a lost decade.

Here in the US, Ben Bernanke's farewell tour included a luncheon on Capitol Hill with Congress-folk, where he received a standing ovation and some of his past critics seemed to go soft. Bernanke offered an optimistic view of the economy, listing the country’s booming energy sector, stronger financial institutions and modest federal budget deficit reductions as positive signs.  Bernanke indicated he is more worried about the economic fate of middle-class families than the federal budget deficit going forward.

Meanwhile, the newly confirmed Federal Reserve Chairwoman, Janet Yellen has granted an interview to Time magazine and here's what she says about the economy: "I think we'll see stronger growth this year. Most of my colleagues on the Fed's policymaking committee and I are hopeful that the first digit [of GDP growth] could be 3 rather than 2... The recovery has been frustratingly slow, but were making progress in getting people back to work, and I anticipate that inflation will move back toward our longer-run goal of 2 percent." On the housing market, which had a brief lull this fall: "I expect it to pick back up and I do expect a further recovery."

Talking about the Fed's QE program, Yellen seems to believe that higher home prices and stock market stimulation is helping the average family. She is clearly a believer in the wealth effect, even though I have to question what data she might be looking at. RealtyTrac just released its Home Equity and Underwater Report for December 2013, which shows that 9.3 million US residential properties were deeply underwater, or about 1 in 5 of every property with a mortgage. "Deeply underwater" is defined as worth at least 25% less than the combined loans secured by the property. There are fewer homeowners who are deeply underwater, but there are still millions who are in serious trouble, and the longer these homeowners remain in a negative equity position without relief in the form of a principal loan balance reduction, the more likely that foreclosure will become the path of least resistance for them.

And on the jobs front, recent data from the Economic Policy Institute shows we're still about 1.3 million jobs below the pre-crisis peak – that's just to get back to break even, and then we would need about 6.6 million more jobs to get to where we need to be, in other words, how many jobs would be needed to employ all the people who would be actively looking for work if the economy were running at full steam.

The 7% unemployment rate is misleading because it is based partly on people dropping out of the work force and no longer being counted as unemployed. The economy is not strong enough to create jobs, so labor-force growth is not living up to its potential. If people who have dropped temporarily out of the labor force were still looking for jobs, the real unemployment rate would be 10.3%, not 7%. In other words, Dr. Yellen's confidence in the wealth effect never filtered down to the actual labor force.

If labor force participation drops, if for whatever reason, millions of people are no longer counted as part of the labor force, as is the case in the US, it’s a troublesome indicator for the economy and the real employment picture. It also makes the unemployment rate, now 7%, look a lot less awful: if you’re not counted in the labor force, and you don’t have a job, you’re not counted as unemployed. There are millions of people in that category. And their numbers are growing, not diminishing. The irony of the U-3 unemployment statistic is the fact that while unemployment has gone down 30% since its 2009 peak, we have the lowest labor force participation rate in over 3 decades.

People 55 to 64 years old, the first forget-about-retirement generation, are staying in the labor force to an ever greater degree. In 1992, only 56.2% were still in the labor force, in 2012, 64.5% were. Similar for older folks. The participation rate for people 65 to 74 years old jumped from 16.3% to 26.8%. Reality is this: fewer people can afford to retire. And the further reality is that the older workers are getting paid less.

The pattern among employers in a downturn in managing the non-executive/senior managerial workforce was to push out higher-cost older workers in favor of cheap, high energy, less set-in-their-ways new hires. Lots of people over 40 were given the heave-ho. Some eventually found work at much lower pay, some became self-employed (it’s a lot harder than the business press lets on; 9 out of every 10 new businesses fail in the first three years), and some retired, living more modestly than they had wanted to.

But who is not making it into the labor force? Young folks. The participation rate for those 16 to 19 has plunged from 51.3% in 1992 to 34.3% in 2012. OK, the BLS explains that by an increase in school attendance, and that would be a good thing. But the 25 to 54 year olds? Even among them, participation rates dropped from 83.3% in 2002 to 81.4% a decade later.

Among the 18 to 34 year old “Millennials,” those lucky ones who’re official counted in the labor force, unemployment has been a nightmare, with double digit unemployment rates, still, nearly 6 years after the financial crisis. It’s even worse for the 16 to 24 year olds, whose official unemployment rate is still 15%. In prior downturns, the employment rate for young adults nearly reached pre-recession levels within 5 years.

In the Great Recession, young adult employment had not even recovered halfway by the same point. A quarter of all job losses for young adults came after the Great Recession was officially over. The lack of jobs had driven many discouraged young people from the labor force altogether. A recent report by Opportunity Nation estimates that 5.8 million young adults are neither working nor in school.

And on the issue of banking reform Yellen says Dodd-Frank is a good road map but there may be a need for further steps. Which may be the biggest understatement of the new year. The Dodd-Frank reform legislation has been moving forward at a snail's pace, and the bank lobbyists are still in the process of re-writing bits and pieces and generally eviscerating key components. And even complete fulfillment of Dodd-Frank along current lines will not end the problem of “too big to fail.” 

Still, it's nice to see an incoming Fed head act like she'll pay attention to the Fed's role as a regulator. Under Alan Greenspan, the Fed was more of a deregulator than a regulator. Under Ben Bernanke, the Fed seemed to be more concerned with crisis control, and any thoughts of regulation were subservient to not letting the banking system implode, even if the bankers had lit the fuse. Now that there is some level of equilibrium, Yellen may actually feel emboldened to … ah hell, let's not get carried away; nothing will change.