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   Brian Wesbury
Chief Economist
 
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  Wedged in a plow horse economy
Posted Under: Government • Video • Fed Reserve • TV • Fox Business
 
Posted on Tuesday, July 29, 2014 @ 2:19 PM • Post Link Share: 
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  Why the Fed struggles with when to raise rates
Posted Under: Government • Video • Fed Reserve • TV • Fox Business
 
Posted on Tuesday, July 29, 2014 @ 2:14 PM • Post Link Share: 
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  Where is the value and growth?
Posted Under: Government • Video • Fed Reserve • TV • Fox Business
 
Posted on Tuesday, July 29, 2014 @ 2:12 PM • Post Link Share: 
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  Is Federal Reserve Policy Complicating the Economy?
Posted Under: Government • Video • Fed Reserve • TV • Fox Business
 
Posted on Tuesday, July 29, 2014 @ 2:10 PM • Post Link Share: 
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  The Fed’s Massive Power Grab
Posted Under: Government • Research Reports • Fed Reserve
Take your pick of these two jobs. You get to manage a $4+ trillion bond portfolio and have omnipotent control over banks and other financial institutions. Or, you can manage an $800 billion portfolio, control the level of the federal funds rate and manage some regulatory issues. Is this really a hard choice? Well, it certainly doesn’t seem to be for the Federal Reserve.

The Fed has seamlessly morphed from an institution that occasionally intervened in financial markets to a monster that apparently wants to control a great deal of the US financial system. Federal Reserve Board Chair, Janet Yellen, and her fellow central bankers, with virtually no pushback from Congress, are in the process of adopting an entirely new economic management technique called “macroprudential regulation.”

The definition of macroprudential regulation is hard to pin down. In short, it means managing systemic risks. This is done by regulating specific financial system behavior in an attempt to avoid cascading economic problems. The idea is that the Fed can reduce the risks of financial instability for the economy as a whole by regulating certain behaviors.

In practice, what this really means is that the Fed wants to run a monetary policy that it believes is appropriate for the economy as a whole – to keep unemployment low. But, if this overall monetary policy causes too much financial risk, the Fed wants to micro-manage that risk by deeming it a macro-risk. At its root, this is hypocritical.

Everyone knows that when the Fed holds rates too low, this encourages some investors to leverage up more than they would otherwise. For example, in 2004-05, the Fed held the federal funds rate at 1% which helped cause a bubble in housing. But, rather than raising rates at that point, the Fed wants to have the right to regulate home lending activity. It could do this in any number of ways, by raising the capital required by banks to make home loans or possibly putting a limit directly on certain types of loans. That’s macroprudential regulation.

In effect – and the Fed has argued this – the Fed blames banks for bubbles, not its strategy of holding interest rates artificially low. This is central planning to the second degree. The Fed wants to set rates first and then police the impact of those rates as if these decisions are not related.

This is a very dangerous precedent and it moves the US away from the free market while continuing to concentrate the power in the hands of the Fed. In a true free market, monetary policy should not be used to manage the economy. Rather, monetary policy should have one goal – to keep the value of the currency stable.

Unfortunately, as is true with all government institutions, the Fed is always looking to expand its influence and power. Remember when Rahm Emmanuel said, “never let a crisis go to waste.”? The Fed has taken this to heart. In the thirty years, between 1977 and 2007, its balance sheet (the monetary base) averaged 5.4% of US GDP. Today, it’s 22.4%. Never, in the history of the United States, outside of the military in World War II, has one government institution been so dominant.

And, under Janet Yellen, the Fed is making a steady, insistent and disciplined argument that growing the Fed’s power is necessary for economic stability. The Fed wants to keep its balance sheet large, hold interest rates low, and regulate banking activities. From a distance this behavior looks awfully like that of the Bank of China.

The alternative would be for the Fed to shrink its balance sheet, hold interest rates where economic fundamentals and the Taylor Rule suggest they should be, and have faith that the free market will police excessively risky behavior. But, the US has entered a new era of doubt about free markets.

This was pre-ordained when Congress passed the Troubled Asset Relief Plan (TARP) in October 2008 – a $700 billion slush fund for the government that was sold as a way to save the world from Wall Street. As President Bush later said, “[We] abandoned free market principles to save the free market system.”

But, by violating free market principles, politicians created conditions which allowed the Fed to justify regulation of the economy in new and broadly expansive ways. Republicans were always the defenders of free markets, but TARP signaled a new era. Now, because the GOP won’t say TARP was a mistake, it has no effective argument against the Fed grabbing more power.

What this means for the economy is that flawed economic models, combined with the very visible hand of regulation, are distorting economic activity and leading the US toward more politicized control of financial markets. What could keep the Fed from lowering capital requirements on clean energy and raising them on fossil fuels? After all, many argue that fossil fuels are destabilizing.

But even more dangerous is that the Fed will hold rates down at artificially low levels for long periods of time in order to bring unemployment back down, all the while believing it can control the risks of easy money by using macroprudential regulation tools.

There are many reasons to disagree with this policy, but the most important is that artificially low rates distort decision making. High-return businesses will lever up unnecessarily and probably show up as bubbles. But some low-return enterprises will wrongly assume that borrowing to expand is still profitable. If resources flow too heavily to low return businesses, the economy will be less efficient and have more danger of inflation.

When rates eventually rise, both these behaviors will be tested and perhaps crack. Rather than trying to figure out where dangerous leverage is being employed, the Fed should put rates at the correct level and keep the whole boom-bust process from happening in the first place.

Congress needs to push back hard against macroprudential regulation, but it’s highly doubtful they will because they don’t understand it. The Fed is expanding its mandate in massive and unprecedented ways. Who is going to stand up and say stop?

Brian S. Wesbury, Chief Economist

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Posted on Monday, July 28, 2014 @ 1:55 PM • Post Link Share: 
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  Tax Reform: The Real Anti-Inversion Solution
Posted Under: Government • Monday Morning Outlook • Taxes
Inversions – a financial deal where a large US company merges with a smaller foreign one and then reorganizes so the US wing of the new firm is the subsidiary and the entity pays a lower foreign corporate tax rate – are the rage these days.

Well, sort of. A few companies have done them, and, according to one lawmaker, maybe 25 more are in the works. The rage is coming from politicians. They argue that inversions are unpatriotic and want to stop them.

There might be some law that could stop inversions, but if politicians are serious, they will push real tax reform. The US has the highest corporate tax rates in the world and it applies that rate to income from anywhere in the world.

A company cares about its customers, employees and shareholders, not the tax collector. Inversions offer US companies a “three-fer.” First, they cut taxes owed on income from foreign operations. Second, the company gets access to foreign profits without repatriating them and paying high US taxes. Third, the new company can, in theory, use the US-wing to borrow money for global operations and deduct the interest it pays from any US income it makes.

Despite the hysteria about inversions, federal corporate tax receipts were $303 billion in the past twelve months, an increase of 11.4% versus a year ago. Taxes on profits have risen faster than profits themselves. So, inversions haven’t crimped anything yet. Moreover, profits get taxed again when they are distributed to shareholders as dividends. So, $1 of corporate profits first gets chopped to 65 cents (from the 35% corporate tax rate), then to 52 cents when it is paid as a dividend and taxed at 20%. This is an effective federal tax rate of 48%.

Any ability to avoid those taxes means lower prices for customers, higher salaries for employees, and greater returns for shareholders. And because the US doesn’t have a territorial system, if a US company makes money anywhere around the world, the IRS wants a share, even if the activity had nothing to do with the US. No wonder companies want to move abroad.

Rather than demagoguing, lawmakers ought to reform the corporate tax code, cutting tax rates on capital and limiting the reach of the IRS to activity that happens here. That would encourage more capital investment and keep US companies from moving abroad for tax purposes. In turn, more investment means higher productivity and higher wages.

Don’t hold your breath, though. That kind of reform will have to wait until at least 2017.

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Posted on Monday, July 28, 2014 @ 11:20 AM • Post Link Share: 
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  New Orders For Durable Goods Increased 0.7% in June
Posted Under: Data Watch • Durable Goods

 
Implications: A Plow Horse report for durables goods orders in June. The good news was that new orders for durable goods increased 0.7% in June and 0.8% excluding transportation, both narrowly beating consensus expectations. The bad news: orders for most major categories of durable goods have been growing more slowly in the past few months. So, despite strong profits and cash on the balance sheet, many companies are still waiting to ramp up business investment. In addition, shipments of “core” capital goods, which exclude defense and aircraft – a good proxy for business equipment investment – declined 1% in June. However, core shipments were still up at a 4.1% annual rate in the second quarter and our models suggest that businesses increased “real” (inflation-adjusted) equipment investment at about a 9% annual rate in Q2. As the broader economy continues to grow, look for orders to pick up some steam. Signaling future gains, unfilled orders for “core” capital goods rose 1.2% in June, hitting a new record high, and are up 8.9% from a year ago. We believe we are nearing a large increase in business investment over the next couple of years. Consumer purchasing power is growing and debt ratios are low, leaving room for an upswing in bigger ticket items. Meanwhile, profit margins are still high, corporate balance sheets are loaded with cash, and capacity utilization is near long-term norms, leaving more room (and need) for business investment. Plugging all of this week’s data into our models suggests real GDP grew at a 2.7% annual rate in Q2. That’s slightly lower than we were estimating a week ago (2.9%) but well within the normal range for a Plow Horse economy.

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Posted on Friday, July 25, 2014 @ 11:00 AM • Post Link Share: 
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  New Single-Family Home Sales Declined 8.1% in June
Posted Under: Data Watch • Home Sales • Housing

 
Implications: Forget about new home sales for a minute. New claims for unemployment insurance dropped 19,000 last week to 284,000, the lowest since February 2006, which was at the peak of the housing boom. The Labor Department said there was nothing unusual about last week’s reports from the states, but noted the data are often volatile this time of year due to summer-related auto plant shutdowns. This suggests there were fewer shutdowns than normal last week. Continuing unemployment claims declined 8,000 to 2.50 million. Plugging these figures into our payroll models, which are rated #1 by Bloomberg for the past two years, suggests nonfarm payrolls increased 218,000 in July, while private payrolls grew 216,000. These forecasts will likely change next week as we get data from ADP and Intuit, as well as one more week of unemployment claims. On the housing front, new single-family home sales dropped steeply in June and were revised substantially lower in May. Today’s report came in well below even the most pessimistic forecast for sales in June. This does not mean we are back in a housing recession; home construction remains in an upward trend and new homes sales have been hovering in the same range for the past two years. There are a few key reasons why new home sales remain so low. First, the homeownership rate remains depressed as a larger share of the population is deciding to rent rather than own. Second, buyers have shifted slightly from single-family homes, which are counted in the new home sales data, to multi-family homes (think condos in cities), which are not counted in the report. Third, financing is still more difficult than it has been in the past. The inventory of new homes rose in June, but still remains very low and most of the inventory gains are for homes not started, instead of homes completed. Homebuilders still have plenty of room to increase both construction and inventories. Once again, the housing recovery remains intact, despite the fits and starts which are to be expected when the overall economy is a Plow Horse, not a Race Horse.

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Posted on Thursday, July 24, 2014 @ 11:46 AM • Post Link Share: 
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  Don’t Believe It, Just Because It’s on TV
Posted Under: CPI • Inflation • Video • TV • CNBC

 
by Brian Wesbury

I knew Milton Friedman, and Rick Santelli is no Milton Friedman. Don’t get me wrong, there isn’t any personal animosity here. Every time I took my Wheaton College class down to the Board of Trade, Rick Santelli spent time speaking to them, treated them with a great deal of respect and was a perfect gentleman. The students loved him.

Rick has earned his spot on TV, makes news, and reflects views about the intersection of government and markets that too few commentators take the time to address.

What I do have a problem with is that Santelli sometimes repeats things on air about the economy that really shouldn’t be repeated. Yesterday (June 22, 2014), was a perfect example.

After the June Consumer Price Index (CPI) data was released, and it continued to show relatively benign readings, Santelli hammered the data for under-reporting inflation. He specifically mentioned electricity prices and used non-seasonally-adjusted electricity price data to make his point.

“Not seasonally adjusted electricity month over month [in June] was up over 5%. We know why: we are closing coal which is electricity generation. Is the government in all its agencies just against the middle class? Are they just slopping them and cutting them off at the ankles or what?”

http://video.cnbc.com/gallery/?video=3000294804


Let’s count the ways he was wrong. 1 – He uses non-seasonally-adjusted data to analyze a monthly number. 2- He pays no attention to past history. 3 – He attributes monthly changes to long-term policy decisions. 4 – He uses one month’s data to argue for a government conspiracy. 5 – He allows his politics to affect his analysis.

As can be seen in the chart above, non-seasonally-adjusted electricity prices are massively volatile. Santelli was correct that they were up 5.2% last month. The problem is that they always jump in June as the weather heats up and people switch from natural gas and oil to heat their homes to electricity to run their air conditioning. Look at the table below. Every June prices go up on a non-seasonally-adjusted basis. June 2014 was no different.

Electricity Prices - June - NSA

2000        6.6%

2001        9.6%

2002        6.2%

2003        5.8%

2004        7.2%

2005        7.8%

2006        7.5%

2007        6.9%

2008        6.7%

2009        4.6%

2010        4.3%

2011        4.1%

2012        4.5%

2013        4.6%

2014        5.2%


Then after rising in June, prices always subside in the months that follow and plummet along with the temperatures in October. They will do so again this year, coal or no coal. Yet, we highly doubt there will be reports on TV if not-seasonally-adjusted electricity prices fall 4.2% in October (the average decline over the past five years).

It is true that electricity prices have been accelerating in recent years, but digging through the data to find one piece that is apparently out of line, or using that single data point to try to prove a macro-point, is misleading and in the end unproductive.

We think the Fed is too easy. We think inflation is on the rise. But, we have consistently said that hyper-inflation is not on the table, and investors who build a portfolio waiting for the sky to fall are highly likely to underperform. TV likes to make noise, but having non-economists make big points by mis-using data is a danger for investors.
Posted on Wednesday, July 23, 2014 @ 2:55 PM • Post Link Share: 
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  The Consumer Price Index (CPI) Increased 0.3% in June
Posted Under: CPI • Data Watch • Inflation

 
Implications: In her last press conference, Janet Yellen said recent higher inflation readings weren't a problem because the data are "noisy." But, lately, that noise all seems to be coming from the direction of higher inflation. Consumer prices increased 0.3% in June, following a large 0.4% rise in May. Although consumer prices are up a moderate 2.1% from a year ago, this year-over-year number masks a real acceleration. Over the past three months, the CPI is up 3.5% at an annual rate. And if you think three months is just noise, how about the first half of the year? In the first six months of 2014, consumer prices are up 2.7% at an annual rate, a clear acceleration from the 1.5% rate seen through the first six months of 2013. Energy led the way in June, with gasoline prices, up 3.3%, accounting for two-thirds of the increase in the overall index. And while a 0.1% increase in "core" prices in June means core prices are up only 1.9% from a year ago, they are still up an annualized 2.5% in the past three months. In addition, owners’ equivalent rent (the government’s estimate of what homeowners would charge themselves for rent), which makes up about ¼ of the overall CPI, is up 2.6% over the past 12 months. This measure will be a key source of the acceleration in inflation in the year ahead, in large part fueled by the shift toward renting rather than owning. The worst news in today’s report was that “real” (inflation-adjusted) average hourly earnings remained flat in June and are down 0.1% in the past year. Plugging today’s CPI data into our models suggests the Fed’s preferred measure of inflation, the PCE deflator, probably increased 0.2% in June. If so, it would be up 1.7% from a year ago, barely below the Fed’s target of 2%. We expect to hit and cross the 2% target later this year, consistent with our view that the Fed starts raising short-term interest rates in the first half of 2015.

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Posted on Tuesday, July 22, 2014 @ 1:11 PM • Post Link Share: 
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These posts were prepared by First Trust Advisors L. P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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