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THE FED QUEST FOR NEUTRALITY

These modern alchemists at the US Federal Reserve are in a pickle. They must promote an image of seeking monetary neutrality in the setting of interest rates. The Greenspan Fed continues to raise short-term targeted rates, with clumsy calls for more “measured pace” hikes. The technical justification is more amusing, if not embarrassing. That is, embarrassing if they intend to pass themselves off as central bankers. They must pose as bankers and play the role. In my view these guys are mere inflation engineers and political representatives from the banking center. A system which has forfeited almost its entire manufacturing base, has outsourced an increasing amount of its services, and relies so heavily on asset inflation, equity extraction, zero-percent transaction finance, such a system cannot revert to normalcy with walking through fire for a prolonged period of time. The current path is pointed in the wrong direction. Instead, what we have is a recurring series of economic fantasies which an ill-trained public is eager to latch onto and an engrained investment community is eager to perpetuate. In the article “Economic Mythology” from almost a year ago, a premise was upheld that in the United States, a complex system has emerged with irrational beliefs which have no bearing on reality. Myths perpetuate because the monetary system cannot stand on its own merits. NOT EVEN CLOSE.

Since Greenspan took the helm almost 18 years ago, we have witnessed a pathogenesis toward the bizarre in monetary leadership which qualifies as incompetent and heretical, the near opposite path laid by Paul Volcker. Sadly, there is no way back. No path of bread crumbs can lead our system back to normalcy. Once upon a time, central banks actually were devoted to legitimate justification of policy, founded in valid economic practices, and not to a scummy outpouring of professionally adolescent excuses for their absurd indefensible policies. To defend the current system, the powers that be use their own printed money to purchase key securities like the 10-yr Treasury Note, like the S&P500 basket, like gold short futures contracts, and have even enlisted the Bank of Japan in collusion. The USFed has ventured so far afield from sane sound scrutinized principles, that its credibility has been undermined. Some say it has lost control over interest rates and the Treasury credit market, as control swings from US shores to ceded Asian shores. An argument can be made that the USFed has morphed into a gigantic monetary drug dealer enterprise. How does a crack cocaine addict turn a new leaf and reform? How does a man who goes through a bottle of Jack Daniels on a daily basis reform? How does a devoted methamphetamine crankhead go straight? It can be done, but it takes a couple years, deep courage, broad support, professional guidance, an excellent plan, and willingness to endure considerable pain. We have none of these.

Greenspan has led us down a dead-end path. Perhaps this is the ultimate destiny of democracy, where mere mortals are in charge of the national purse and monetary spigot. We are long past the nonsense of “Trickle Down” beliefs in the 1980 decade of supply side economics. It did not trickle down, but we still claim it did. We cling to faded memories of the nonsense in the 1990 decade for the “Technology Miracle” based upon productivity. Consumers, not businesses, saw the benefits in lower prices and a flatter playing field which yielded lower profits. Its miracle is still trumpeted by a clueless Greenspan, totally ignorant of technology, if truth be known. He does not even use email, could not download a file to save his shocks of wispy hair, and possesses no mouse skills. In the last couple years, we have been subjected to more heresy in the “New Economy” nonsense. International credit flexibility (more like welfare, confiscation, and dependence) combined with asset inflation (justified as wealth generation). The world monetary system has de-evolved into a Bretton Woods Plastic Accord, as the US “plastic” credit card economy relies upon unending surpluses from Asian benefactors. We have tragically become dependent on the generosity of strangers, even as we pursue their aggravation.

REAL ECONOMIC NEUTRALITY

Any attempt to discuss and rationalize sound economic policies based on time-tested survival, nowadays is met with mockery, laughter, and derision. The word “neutrality” has been bandied about in recent months as the USFed has reversed its measured ratcheted inflationary machinery and madcap lab-rat experimentation. What is neutrality to those people who stand on ground based in reality? An interest rate can be deemed neutral when it encourages a stable balance between supply and demand for money. What a novel thought!!! What does that mean though? Money is supplied from savings (not a printing press). Money is demanded by borrowers for productive usage (not speculation). A proper neutrality in interest rates is achieved when personal saving & business investing are in balance. Focus is on productive borrowing to create new businesses, to expand the labor force, to generate income. It is not borrowing to go on cool vacations, to purchase that cute lakeside cottage, to finance a room addition on the homestead (empty nest from long departed children), nor to get the resident teenager a car. A downstream measuring stick of proper neutrality is seen in actual monetary growth. It is achieved when the economy grows at the same rate as the money supply.

The United States has negative savings, near nil business investment, and money supply growing at 5 to 7 times the actual economic growth rate. In 1995, credit expansion was four times the available national savings, $1.13 billion versus $310B. By 2004, credit expanded by $2720 billion, almost 20 times as much as a pitiful savings rise of $130B. And that savings total permits inclusion of nonsensical $800 billion in homeowner self-paid rent. Yes, the US savings rate is negative, probably as much as minus 1.0% to 1.5%. This outcome is not even remotely close to neutral, not even in the same time zone. No balance is achieved when the amount required to borrow for a wide variety of loans overwhelms the amount contributed to savings. Therein lies the problem when the nation has no savings and invests most new capital in Asia.

In order to keep the charade going, the United States, its trading partners, and investors worldwide must be fooled, tricked, and deceived by myths. The myths help to obscure the wholly fallacious and destructive policies at work. Without such myths, we would be forced to endure a painful correction to inflated assets, and be subjected to a severe debt downgrade. In my analysis such a day is put off and delayed, not avoided and circumvented. Well, unless the political systems change in a profound manner!!!

CURRENT STATED RATIONALE

One could stretch the definition of US neutrality to include the entire global economy. Asian savings supplies capital for business investment in an attempt to seek balance. But it more realistically supplies credit within the United States for a deepening obligation of Medicare expenses, a rationalized shrug of tax structure levies, US Military war spending, a frenzied housing speculation, and broad bond speculation. Recall that our free market will lend money for anyone to pursue a dream, as long as you have the income. NO WAIT!!! Housing loans only require a good solid credit rating in many cases. So a person with a sterling credit record can conceivably borrow almost endlessly even after walking away from the employment bridle, bit, and yoke. The balance has a self-dealing nature about it. The Asian savings has as its origin the US bank system largesse, pure federal monetization and private sector credit creation, which produces mountains of trade surpluses for exporters in the Far East. Money off the US inflation printing press becomes transformed into Asian savings. It is not savings at all, but rather evidence of capital draining (blood hemorrhage) collected in Asian central bank depositories (blood vats).

The USFed is caught in another bind of its own making, in seeking neutrality. They rely upon the GDP (gross data pollution) for economic growth measurement and CPI (constant price index) for guidance on the effect on chronic inflationary policy. They react to the housing bubble like a dog chasing its tail, and have actually confused themselves. Greenspan has spent more time selling his policies than actually working to make them well studied and sensible. Thus, my label of him being the senator from the state of Wall Street. He has stated his goal of sustained economic growth against a landscape of tepid price inflation. If reality were introduced into the mix, one would have to admit that over half of GDP growth is the product of statistical fiction and creative accounting. See the recent “Three Great Big Lies” for details on how the US stat lab maestros have deceived us mightily. US ECONOMIC GROWTH RELIES UPON AN ABSURD PRICE DEFLATOR, one which actually claims that prices are rising more slowly than the broken CPI index. Raw economic activity numbers must be reduced by price inflation. The more slack during the job done in adjustment, the more baseless and corrupted the claimed robust economic growth. Most economic growth is improperly and inadequately adjusted price inflation for materials, energy, and foodstuffs. Much of what we call economic growth is simply price inflation, without any doubt in my mind. We rag on about slow stodgy European growth, when they do not lie so systematically and pervasively. We lie institutionally, and in recent months, we lie without the cover of much credibility. Anyone with half a brain can see that half of US official statistics are dishonest. Anyone with a decent education can see that the majority of US official statistics are founded in promotional spin in order to sell our story for the attraction of foreign capital.

Furthermore, even by the USFed’s own cry of neutral rates with respect to consumer price inflation, prices are rising much faster than rates. The annualized CPI jumps in Feb, March, April of 2005 were 6.9%, 9.4%, and 8.1% respectively, only to taper off a bit later in the spring after crude oil fell in price. It seems, in this Orwellian Age, we proclaim neutrality when we are nowhere near it. In the legal world, a device is often used to argue a case, using a “reasonable man” and his behavior, beliefs, and preferences. Well, no reasonable man or woman believes the consumer price inflation is actually under 5%, not in this world. Enough space is usurped is establishing the premise that the CPI vastly understates actual inflation. No more here. Let it suffice that the GDP is much slower than the 3.0% to 4.0% reported, and the CPI is much higher than the 2.0% to 3.0% reported. Take away the huff, puff, spin, and bull cookies, and even under the new neutrality guidelines, the USFed is way past neutral on the side of accommodation. If we ever reach neutrality, the interest rate will be so high that the US Economy will come to a grinding halt. Price inflation far exceeds economic growth. The inflation dependent system wants cheap money. We care more about the price of money than the price of real tangible things, and have the audacity to boast of our progress in evolution.

ACTUAL PURSUED UNSTATED PLAN

In my opinion, and bear in mind this is only my conjecture, founded upon a mix of professional analysis and personal judgment from many years of observation, the USFed has an unspoken goal which in no way does it wish to be made public. This view is hardly conspiratorial, but rather extremely practical. The US Economy has as its faulty foundation the housing sector. The vulnerability to our national economy, its vibrancy, its financial health is unspeakable and enormous.

As the USFed has raised short-term interest rates over a stretch of 14 months, the adjustable mortgage rate (ARM) has gradually risen. Owing to the Bond Conundrum, the long-term interest rates have remained tame, in defiance to Greenspan. For whatever reasons, actually thoroughly covered in my past writings, long-term rates have permitted the fixed mortgage rate to be roughly the same as a year ago. Ten basis points is insignificant to bring down the housing superstructures. The consequence to mortgages from the Fed tightening has been convergence of the ARM to the fixed mortgage rate, possibly their objective.

It is my contention that the USFed march toward neutrality is achieved when ARMs are nearly equal to fixed mortgage rates. That is their unstated goal. At that point, homeowners can swap into fixed mortgages, lock their rates, and protect themselves from a potentially higher interest rate environment. It would be painful enough if housing prices go into decline. It would be doubly painful if household monthly costs were to rise at the same time, a doubly whammy to their balance sheets and monthly budgets.

In no way can Chairman Greenspan openly reveal this objective in monetary neutrality. That would be tantamount to an admission that the entire national economy rested atop a housing bubble. We all realize it, but cannot be told this. We all know the risks and danger when a structure is built atop unstable moorings. It has no foundation and no capstone. Watch for the Mad Maestro, the Pied Piper, the Wizard of Oz, the blatant charlatan, to urge homeowners into a swap from ARM to fixed mortgages. His urge to swap in fixed contracts will be the signal in my view that the Fed tightening cycle is at an end, and neutrality will be proclaimed. We need new measuring sticks when a nation has negative savings, when an entire economy is debt dependent and highly reliant upon inflating assets. Old tested meters cannot be applied. New meters can be loosely stated, provided not too much laughter ensues. Credibility must be maintained in order to preserve confidence in the absurd system. But the real meter comes from the basement bowels of the burgeoning housing bubble and its shifting sands of financial foundation. A hundred more questions can be offered to the table on the quest for neutrality, and the impact of its inevitable failed pursuit. Many are covered in my Hat Trick Letter, where such issues are regularly discussed. The Fed ain't done hiking. They ain't done doing damage. They clearly march to the beat of a psychotic drummer.

HAS ANYONE NOTICED HOW FANNY MAE IS NO LONGER IN THE NEWS? ONE CAN SAFELY CONCLUDE THAT ITS BANKRUPTCY RECEIVERSHIP REMEDY IS WELL ALONG. THE DEPT OF TREASURY HAS MANAGED THE ABSORPTION AND ASSIMILATION OF ITS CRIPPLED PORTFOLIO. WHETHER LEGAL OR NOT, WHO KNOWS? THE VACANT CAPITAL CORE IS NOT A CONCERN, A SIGN OF THE TIMES.

NEWS TIDBITS

The Fed “beige book” summary of economic conditions said US business activity continued to grow in June and early July, and overall price pressures eased or were flat in most places despite higher energy and building costs. Only the New York district reported a slowing in the rate of economic growth. Many districts reported substantial increases in the costs of energy, petroleum-based products, and building materials such as concrete and plywood. Despite those gains, price pressures either slackened slightly or were unchanged in most districts. (translation: plenty of actual price inflation but no statistical price inflation!!!) Wage pressures were moderate in nearly all districts. At the same time, Dallas reported wage pressures in the accounting and energy professions, while Chicago noted pressures in some skilled professions. Loan demand increased or remained solid on increases in mortgage, home equity, and business borrowing in most districts. On a personal note, after reading so often about national savings and its curious corrupted calculation, I am pleased to announce that I will hereby spend my entire self-paid rent from my house for all my telephone, insurance, gasoline, and entertainment expenses.

Orders for durable goods rose unexpectedly last month, while a key proxy for business spending also rallied sharply. The Commerce Department said demand for long-lasting goods gained 1.4% in June. It also revised May's already-strong reading to show a 6.4% jump compared with a previously reported 5.5% rise. Orders excluding volatile transportation equipment rose 2.6%. Non-defense capital goods orders excluding aircraft, seen as a proxy for business spending, jumped 3.8% from a 0.6% decline in May.

Sales of new US homes jumped 4.0% in June, exceeding expectations and striking a record high as median sales prices declined for the second month in a row. The Commerce Department said new single-family home sales rose to a seasonally adjusted annual rate of 1.374 million units, from an upwardly revised 1.321 million unit rate in May. The June sales pace was 14% higher than a year ago. The inventory supply of homes for sale at the end of June stood at a record 454,000, up 2.5% from May and 18.5% higher than a year ago. At the current sales pace, the supply of homes represented 4 months worth in June. The national median sales price of a new home fell 5.5% to $214,800 from $227,400 in May. The average sales price on a new home fell to $267,400 in June from $287,400 the previous month.

Applications for US home mortgages decreased last week, pulled lower by a sharp decline in refinancing activity, despite steady long-term interest rates, according to an industry group. The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity (a measure of mortgage loan application volume) fell 5.8% to 754.3 in the week ending July 22, more than offsetting the previous week 1.2 gain. On a four week moving average, the index is down 1.3% to 795.8 from 806.2. The MBA seasonally adjusted index of refinancing applications dropped 11.4% to 2,320.3 after rising 2.5% the prior week.

Chinese oil company CNOOC estimates the state subsidy in its $18.5 billion offer for Unocal is only $815 million, just one-eighth of what rival bidder Chevron claimed in a recent public charge. Conditions set by the Chinese firm for a higher offer, set out prior to an increased bid from Chevron last week, were more reasonable than some investors thought. People close to Chevron Corp said this week Beijing was subsidizing the $67 per share CNOOC offer by as much as $23 per share through soft loans from its parent. But the CNOOC spokesman said this calculation “bears no resemblance to reality” and analysts said it assumed an extreme scenario. “We estimate that it is around $3 a share,” he said.

WorldCom former chief financial officer Scott Sullivan will have to give up a Florida mansion as part of a financial settlement with investors stemming from the collapse of the telecom company. Sullivan, former controller David Myers, and  former accounting director Buford Yates have agreed to settle a class action suit with stock and bond holders, according to a court memorandum in Manhattan.

A mad cow was detected, shocking news. It was traced to have been born inside the United States. Its carcass was destroyed post haste. Again on a personal note, I am dismayed to reveal that two of my large female friends are mad cows.

Boston RedSox pitcher Matt Clement was hit in the head with a line drive batted ball, in a frightening incident. He has rejoined the team, but continues to be under observation. Clement is one of the brightest star pitcher in the major leagues. Meanwhile veteran pitcher Curt Schilling struggles to regain his old form, working in relief, in the hope to shore up the bull pen and stem the blood loss from blown saves. The New York Yankees remain very old, very slow, very ugly, very overpaid, and over the hill, except for Alex Rodriguez, Gary Sheffield, Jason Giambi, and Mariano Rivera (who are tough as nails). Maybe next season the NY Yankees can purchase the entire major league all-star team?

TODAY’S MARKET

Today the Dow Jones Industrials wrapped up at 10,637 (+57), S&P at 1236.8 (+5.6), Nasdaq at 2186 (+10), TENS yield 4.261% (+2.2 bpt). Currencies closed with Euro at 121.04 (0.55), JYen at 89.54 (+0.07), Can$ at 80.98 (-0.43). Metals finished with gold at 426.2 (+1.3), silver at 704.0 (+2.2), copper at 162.70 (+0.21). Energy ended with crude oil at 59.25 (+0.05), natural gas at 757.0 (+11.2), unleaded at 169.75 (+2.47). Prices are at major futures contracts.

Jim Willie CB

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