Excessive Spending - What Always Works

Oil prices continue to remain high despite slowing consumption and rising interest rates in the U.S.

In previous posts, I have voiced the opinion that the Fed's action to fight oil-price based inflation with higher interest rates will slow the U.S. economy... which has always worked..., but not much else. The latest data showing China's demand for oil rising almost 11% over prior year is an example of how forces outside of the Federal Reserve's control are nullifying the global effect of U.S. interest rates and driving the U.S. economy toward another downturn... in areas other than where recession level unemployment already exists.

Meanwhile, actions that could lead to less reliance on oil are being ignored or fought:

• Building new nuclear power facilities
• Developing non-fossil fuel alternatives that can be generated from power supplied by nuclear energy:
• Hydrogen gas fuels
• Battery-only vehicles
• Fuel cells

I learned a long time ago in business not to leave key decisions to finance staff. They tend to focus too tightly on the immediate rather than the long term and that can and does lead to really bad strategic decisions.

Memory

Life after death. Heaven. Hell. Unknowns.

Those who lived, fought, protected, and died before us are the only ones who can answer the really big questions. The rest of us are left with the memories of who they were or what they did. It is our ability to document our histories as a species that give us a chance to progress as a species.

Today we honor those who served in our armed forces; especially those who gave their lives to allow us to go forward under the laws and traditions of free people. We preserve their histories because they protected ours.

A New World Order?

The Detroit Red Wings had the best regular season record and lost in the first round of the playoffs.

The Detroit Pistons had the best regular season record and are losing in the second round of the playoffs.

The Detroit Tigers have the best regular season records and ... what am I saying... have the best regular season record??? The Detroit Tigers???

Where was I?

Open Letter to the Federal Reserve Board

CHICAGO, May 18 (Reuters) - It is "pretty clear" that the U.S. housing market is cooling off but it looks poised for a soft landing given overall strength in the economy, U.S. Federal Reserve Chairman Ben Bernanke said on Thursday.

"Pretty clear" and "cooling" are dramatic understatements for Michigan. Actions by the Federal Reserve are causing severe economic problems for this state which "clearly" never recovered from the previous recession. A 7.2% unemployment rate and a housing market that has collapsed are viewed only within the context of the "national average".

That's like treating a broken neck with message therapy. On average, the rest of the body isn't in bad shape... just needs some adjustments.

Excessive Spending - The Fed: Misery Loves Company

Soooo... the Fed will make sure that more people share the inflationary pain of having things less affordable by making more things less affordable.

Quick doctor, the patient is bleeding profusely so we must draw out some blood so that he won't have as much to bleed out. Well, you have to admit that there is a certain logic to that.

Duh!

Oh, and one piece of evidence that the Federal Reserve is VERY EFFECTIVE at whatever it tries:

Michigan Unemployment Rate (Seasonally Adjusted)
April 2006 Change Over Month	7.2 % + 0.4

Excessive Spending - Current Account

The question keeps coming back: is the current account deficit (balance of trade) good or bad for the U.S.? Apparantly, the answer is yes, no, maybe... depending on which expert you read.

From Reuters:

Following are data on
official dollar holdings worldwide,
ranking reserve totals by country and size
and compared with
the size of U.S. fiscal deficits
and bond markets.
--------------------------------------------------------------
INTERNATIONAL FOREIGN CURRENCY RESERVES
--------------------------------------------------------------
TOP 10 CENTRAL BANK RESERVE HOLDINGS (in billions):
        Latest    End-2005  End-2000
China#     $875 (Mar)  $819       $166
Japan*     $839 (Apr)  $829       $347
Taiwan     $259 (Apr)  $253       $107
SKorea     $223 (Apr)  $210       $ 96
Euro zone* $200 (Apr)  $196       $240
India*     $154 (Apr)  $131       $ 40
Russia*    $153 (Apr)  $137       $ 28
Hong Kong* $127 (Apr)  $124       $108
Singapore* $128 (Apr)  $117       $ 80
Malaysia   $ 76 (Apr)  $ 71       $ 26
* = excluding gold, SDRs, other assets
- Total rise of these 10 in April, ex China = $40 bln
- Total rise of these 10 in 2006 = $147 bln, or 5.1 percent
- Total rise in 2005 = $277 bln, or 8.7 percent
- Total rise since 2000 = $1,796 bln

What is obvious is a remarkable increase in the current account deficit - to 7% of the GDP. Wha t is not obvious is whether that is a problem or not.

Dr. Don Boudreaux, Chairman of the George Mason Economic Department, is adamant that this is not a problem... rather it is a sign of exceptional strength in the U.S. economy.

Others are not so sure:

US current account deficit 'unsustainable' – NY Fed chief
By Christopher Swann in Washington
Published: January 23 2006 19:29 | Last updated: January 23 2006 19:29

Timothy Geithner, president of the New York Federal Reserve, on Monday dismissed the view that the US current account deficit was sustainable, suggesting the risk of a sudden fall in the dollar would grow the longer the trade gap widened.

Still others are certain it is a problem:

The current account deficit indicates that the United States is purchasing about 7% more than it is producing. It needs to import about $2.5 billion per day in foreign capital to finance this deficit. As a result, the net U.S. international investment deficit reached $2.5 trillion in 2004 and likely exceeded $3 trillion at the end of 2005 (net international investment data for 2005 will be released on June 29). Foreign central banks and other private investors held $2.2 trillion in U.S. treasury securities at the end of the fourth quarter of 2005; foreign central banks held the sizeable majority (63%) of that government debt.

As long as the U.S. maintains sizeable current account deficits, net borrowing and payments to foreign investors will continue to grow. The standard of living of future generations will be depressed by the need to pay for today's heavy borrowing from abroad.

But then others say it is just the way it should be... neither good or bad:

International Finance Discussion Papers

The U.S. Current Account Deficit and the Expected Share of World Output Charles Engel; John H. Rogers 2006-856

Abstract: We investigate the possibility that the large current account deficits of the U.S. are the outcome of optimizing behavior. We develop a simple long-run world equilibrium model in which the current account is determined by the expected discounted present value of its future share of world GDP relative to its current share of world GDP. The model suggests that under some reasonable assumptions about future U.S. GDP growth relative to the rest of the advanced countries -- more modest than the growth over the past 20 years -- the current account deficit is near optimal levels. We then explore the implications for the real exchange rate. Under some plausible assumptions, the model implies little change in the real exchange rate over the adjustment path, though the conclusion is sensitive to assumptions about tastes and technology. Then we turn to empirical evidence. A test of current account sustainability suggests that the U.S. is not keeping on a long-run sustainable path. A direct test of our model finds that the dynamics of the U.S. current account -- the increasing deficits over the past decade -- are difficult to explain under a particular statistical model (Markov-switching) of expectations of future U.S. growth. But, if we use survey data on forecasted GDP growth in the G7, our very simple model appears to explain the evolution of the U.S. current account remarkably well. We conclude that expectations of robust performance of the U.S. economy relative to the rest of the advanced countries is a contender -- though not the only legitimate contender -- for explaining the U.S. current account deficit.

Excessive Spending - Rose-Colored Glasses

The government proclaims a robust economy. The Fed raises the prime rate to keep things under control. Meanwhile, in the real world:

The Current Account Deficit and the extreme shift to imported goods has weakened the U.S. currency and the effects are being exacerbated by the Fed's actions -

May 12 (Bloomberg) -- U.S. stocks fell as a jump in prices for imported goods and a drop in the dollar raised concern inflation will accelerate. The Standard & Poor's 500 Index headed for its biggest weekly loss since October.

The government report showing April import prices rose the most in seven months followed a surge in oil and metals prices this week and the 16th straight interest-rate increase by the Federal Reserve.

Remember, if it costs more because we have a stupid approach to imports, it will cost even more because we have an illogical approach to interest rates.

Well, think about it. All of the "market force" experts say let the marketplace handle itself. They don't say, "Let the marketplace be dominated by guesses from the Federal Reserve about what the marketplace is doing."

The Federal Reserve seemed content with the situation as long as cheap imports (supported by manipulated Chinese currency) kept prices artificially low, but the threat of a market correction to reflect untenable imbalances send the Fed into spasms of reactive rate hikes... a double blow to the economy. If imports and oil prices are going up too fast, let the consumers fix it by buying less (which they are) or manufacturers fix it by not buying imports (which they can).

No, the Fed needs to "fix" things by itself... like drawing blood from a bleeding man.

Excessive Spending - Global Inflation; National Response

50 years ago, when the U.S. sneezed the rest of the world caught pneumonia.

The Federal Reserve still lives in that world. Apparently, it sees the potential inflationary impact of oil prices as a problem that the U.S. can solve by raising interest rates... even though the marketplace has pretty well reflected the dampening effect that oil prices have had on our spending habits.

Consequently, in the U.S. we can expect the following:

• Higher interest rates will slow the U.S. economy... housing starts are way down already and people are dipping into savings to fund their normal living needs
• Demand for gasoline has already dropped because of the price of gasoline; the sale of new vehicles will drop significantly due to interest rates
• Unemployment will rise as the cost of doing business in the U.S. rises
• Areas of the country that have already been impacted by manufacturing downturn and low growth will have declining economies

But the problem is that will not cause pneumonia in the rest of the world:

• Political unrest in oil producing countries, plus China and India have a growing need for oil products because the U.S. has jump-started their economies and they can now grow internally rather than be dependent on exports are external factors independent of U.S. demand for oil... and the U.S. will discover that raising our interest rates does not reduce oil prices - U.S. Federal Reserve - strike one!
• To remain competitive, U.S. manufacturers will be forced to export more jobs and production to China and India in order to further reduce their costs to offset the higher costs from interest rates thereby exacerbating economic decline - U.S. Federal Reserve - strike two!
• U.S. citizens will dramatically reduce their savings or further increase their debt levels to offset inflation from oil prices and lower incomes, thereby weakening the U.S. economic base - U.S. Federal Reserve - strike three!

We're out!

The Federal Reserve overreacted in the first years of the decade and is overreacting again.

Excessive Spending - Crash... Tinkle

The Fed struck again and indicated that it felt so good it probably will do it again in June.

After the Fed on Wednesday raised its target for the federal funds rate to 5 percent, most banks began boosting the prime rate they charge their best customers to 8 percent from 7.75 percent.

The prime rate has risen from 4 percent in June 2004, and is at its highest level since April 2001.

Yup, that's about when the economy started going sour the last time. Are there really economic cycles or is it just the Fed trying too hard? Maybe last time and this time the answer is the latter?