Interest Rates and Inflation???

[squiffy]

From Mar. 2004 issue of Money Magazine at p. 53

"With $75 billion in assets, Pimco Total Return ranks as the world's largest bond fund and is a staple of 401(k) plans. So it was news when manager Bill Gross told the New York Times in January that he had yanked some of his own money out of the fund. Why? Gross expects bond prices to drop as investors -- looking at spikes in the deficit and government spending -- bet on a return of inflation and high interest rates. In other words, Gross does not see much opportunity to make money in his own fund."

[adios]

Alan Greenspan in his prepared statement for Congress prior to his testimony had a few comments about inflation. The alternative viewpoint to Gross if you will. Some excerpts:

Looking forward, the prospects are good for sustained expansion of the U.S. economy. The household sector's financial condition is stronger, and the business sector has made substantial strides in bolstering balance sheets. Narrowing credit risk spreads and a considerable rally in equity prices have reduced financing costs and increased household wealth, which should provide substantial support for spending by businesses and households. With short-term real interest rates close to zero, monetary policy remains highly accommodative. And it appears that the impetus from fiscal policy will stay expansionary, on net, through this year. These circumstances all should spur the expansion of aggregate demand in 2004. At the same time, increases in efficiency and a significant level of underutilized resources should help keep a lid on inflation.

and this,

A consequence of the rapid gains in productivity and slack in our labor and product markets has been sustained downward pressure on inflation. As measured by the chain-weighted price index for personal consumption expenditures excluding food and energy, prices rose less than 1 percent in 2003. Given the biases in such indexes, this performance puts measured inflation in a range consistent with price stability--a statutory objective of the Federal Reserve and a key goal of all central banks because it is perceived as a prerequisite for maximum sustainable economic growth.

and this

The recent performance of inflation has been especially notable in view of the substantial depreciation of the dollar in 2003. Against a broad basket of currencies of our trading partners, the foreign exchange value of the U.S. dollar has declined about 13 percent from its peak in early 2002. Ordinarily, currency depreciation is accompanied by a rise in dollar prices of imported goods and services, because foreign exporters endeavor to avoid experiencing price declines in their own currencies, which would otherwise result from the fall in the foreign exchange value of the dollar. Reflecting the swing from dollar appreciation to dollar depreciation, the dollar prices of goods and services imported into the United States have begun to rise after declining on balance for several years, but the turnaround to date has been mild. Apparently, foreign exporters have been willing to absorb some of the price decline measured in their own currencies and the consequent squeeze on profit margins it entails.

and this,

Besides the chronic concern about a sharp spike in oil or natural gas prices, a number of risks can be identified. Of particular importance to monetary policy makers is the possibility that our stance could become improperly calibrated to evolving economic developments. To be sure, the Federal Open Market Committee's current judgment is that its accommodative posture is appropriate to foster sustainable expansion of economic activity. But the evidence indicates clearly that such a policy stance will not be compatible indefinitely with price stability and sustainable growth; the real federal funds rate will eventually need to rise toward a more neutral level. However, with inflation very low and substantial slack in the economy, the Federal Reserve can be patient in removing its current policy accommodation.

The 10 year treasury and 5 year treasury have hit a brick wall at 4% and 3% respectively. Both are close to this recent high in value. We'll see what happens. The Fed obviously believes the deflation risks have been mitigated.


The full text of his prepared statement.
web page (http://www.federalreserve.gov/BoardDocs/HH/2004/february/testimony.htm)

Testimony of Chairman Alan Greenspan
Federal Reserve Board's semiannual Monetary Policy Report to the Congress
Before the Committee on Financial Services, U.S. House of Representatives
February 11, 2004

Chairman Greenspan presented identical testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, on February 12, 2004




Mr. Chairman and members of the Committee, I am pleased to be here today to present the Federal Reserve's Monetary Policy Report to the Congress.
When I testified before this committee in July, I reported that conditions had become a good deal more supportive of economic expansion over the previous few months. A notable reduction in geopolitical concerns, strengthening confidence in economic prospects, and an improvement in financial conditions boded well for spending and production over the second half of the year. Still, convincing signs of a sustained acceleration in activity were not yet in evidence. Since then, the picture has brightened. The gross domestic product expanded vigorously over the second half of 2003 while productivity surged, prices remained stable, and financial conditions improved further. Overall, the economy has made impressive gains in output and real incomes; however, progress in creating jobs has been limited.

Looking forward, the prospects are good for sustained expansion of the U.S. economy. The household sector's financial condition is stronger, and the business sector has made substantial strides in bolstering balance sheets. Narrowing credit risk spreads and a considerable rally in equity prices have reduced financing costs and increased household wealth, which should provide substantial support for spending by businesses and households. With short-term real interest rates close to zero, monetary policy remains highly accommodative. And it appears that the impetus from fiscal policy will stay expansionary, on net, through this year. These circumstances all should spur the expansion of aggregate demand in 2004. At the same time, increases in efficiency and a significant level of underutilized resources should help keep a lid on inflation.

In retrospect, last year appears to have marked a transition from an extended period of subpar economic performance to one of more vigorous expansion. Once again, household spending was the mainstay, with real personal consumption spending increasing nearly 4 percent and real outlays on residential structures rising about 10 percent. Last year's reductions in personal income tax rates and the advance of rebates to those households that were eligible for the expanded child tax credit boosted the growth of real disposable personal income. The very low level of interest rates also encouraged household spending through a variety of channels. Automakers took advantage of low interest rates to offer attractive incentive deals, buoying the purchase of new vehicles. The lowest home mortgage rates in decades were a major contributor to record sales of existing residences, engendering a large extraction of cash from home equity. A significant part of that cash supported personal consumption expenditures and home improvement. In addition, many households took out cash in the process of refinancing, often using the proceeds to substitute for higher-cost consumer debt. That refinancing also permitted some households to lower the monthly carrying costs for their homes and thus freed up funds for other expenditures. Not least, the low mortgage rates spurred sales and starts of new homes to very high levels.

These developments were reflected in household financing patterns. Home mortgage debt increased about 13 percent last year, while consumer credit expanded much more slowly. Even though the ratio of overall household debt to income continued to increase, as it has for more than a half-century, the rise in home and equity prices enabled the ratio of household net worth to disposable income to recover to a little above its long-term average. The low level of interest rates and large volume of mortgage refinancing activity helped reduce households' debt-service and financial-obligation ratios a bit. And many measures of consumer credit quality improved over the year, with delinquency rates on consumer loans and home mortgages declining.

A strengthening in capital spending over 2003 contributed importantly to the acceleration of real output. In the first quarter of the year, business fixed investment extended the downtrend that began in early 2001. Capital spending, however, ramped up considerably over the final three quarters of 2003, reflecting a pickup in expenditures for equipment and software. Outlays for high-tech equipment showed particular vigor last year. Even spending on communications equipment, which had been quite soft in the previous two years, accelerated. A growing confidence of business executives in the durability of the expansion, strong final sales, the desire to renew capital stocks after replacements had been postponed, and favorable financial conditions all contributed to the turnaround in equipment spending.

By contrast, expenditures on nonresidential structures continued to contract on balance, albeit less rapidly than in 2001 and 2002. High vacancy rates for office buildings and low rates of capacity utilization in manufacturing evidently limited the demand for new structures. Inventory investment likewise failed to pick up much momentum over the year, as managers remained cautious. Firms finished 2003 with lean inventories relative to sales, an encouraging sign for the expansion of production going forward.

To a considerable degree, the gathering strength of capital spending reflects a substantial improvement in the financial condition of businesses over the past few years. Firms' profits rose steeply during 2003 following smaller gains in the previous two years. The significantly stronger cash flow generated by profits and depreciation allowances was more than adequate to cover rising capital expenditures in the aggregate. As a result, businesses had little need to borrow during 2003. For the nonfinancial business sector as a whole, debt is estimated to have grown just 3-1/2 percent.

Firms encountered very receptive conditions in longer-term credit markets in 2003. Interest rate spreads on both investment-grade and speculative-grade bond issues narrowed substantially over the year, as investors apparently became more confident about the economic expansion and saw less risk of adverse shocks from accounting and other corporate scandals. Corporate treasurers took advantage of the attractive market conditions by issuing long-term debt to lengthen the maturities of corporate liabilities.

As a consequence, net short-term financing was extremely weak. The stock of business loans extended by banks and commercial paper issued by nonfinancial firms declined more than $100 billion over the year, apparently owing to slack demand for short-term credit rather than to a constriction in supply. Interest-rate spreads on commercial paper, like those on corporate bonds, were quite narrow. And although a Federal Reserve survey indicates that banks had continued to tighten lending conditions early in the year, by the second half, terms and standards were being eased noticeably. Moreover, responses to that survey pointed to a lack of demand for business loans until late in the year.

Partly as a result of the balance-sheet restructuring, business credit quality appears to have recuperated considerably over the past few years. Last year, the default rate on bonds fell sharply, recovery rates on defaulted issues rose, the number of rating downgrades moderated substantially, and delinquencies on business loans continued to decline. The improved balance sheets and strong profits of business firms, together with attractive terms for financing in open markets and from banks, suggest that financial conditions remain quite supportive of further gains in capital spending in coming quarters.

The profitability of the business sector was again propelled by stunning increases in productivity. The advance in output per hour in the nonfarm business sector picked up to 5-1/4 percent in 2003 after unusually brisk gains in the previous two years. The productivity performance of the past few years has been particularly striking in that these increases occurred in a period of relatively sluggish output growth. The vigorous advance in efficiency represents a notable extension of the pickup that started around the mid-1990s. Apparently, businesses are still reaping the benefits of the marked acceleration in technology.

The strong gains in productivity, however, have obviated robust increases in business payrolls. To date, the expansion of employment has significantly lagged increases in output. Gross separations from employment, two-fifths of which have been involuntary, are about what would be expected from past cyclical experience, given the current pace of output growth. New hires and recalls from layoffs, however, are far below what historical experience indicates. To a surprising degree, firms seem able to continue identifying and implementing new efficiencies in their production processes and thus have found it possible so far to meet increasing orders without stepping up hiring.

In all likelihood, employment will begin to grow more quickly before long as output continues to expand. Productivity over the past few years has probably received a boost from the efforts of businesses to work off the stock of inefficiencies that had accumulated in the boom years. As those opportunities to enhance efficiency become scarcer and as managers become more confident in the durability of the expansion, firms will surely once again add to their payrolls.

A consequence of the rapid gains in productivity and slack in our labor and product markets has been sustained downward pressure on inflation. As measured by the chain-weighted price index for personal consumption expenditures excluding food and energy, prices rose less than 1 percent in 2003. Given the biases in such indexes, this performance puts measured inflation in a range consistent with price stability--a statutory objective of the Federal Reserve and a key goal of all central banks because it is perceived as a prerequisite for maximum sustainable economic growth.

The recent performance of inflation has been especially notable in view of the substantial depreciation of the dollar in 2003. Against a broad basket of currencies of our trading partners, the foreign exchange value of the U.S. dollar has declined about 13 percent from its peak in early 2002. Ordinarily, currency depreciation is accompanied by a rise in dollar prices of imported goods and services, because foreign exporters endeavor to avoid experiencing price declines in their own currencies, which would otherwise result from the fall in the foreign exchange value of the dollar. Reflecting the swing from dollar appreciation to dollar depreciation, the dollar prices of goods and services imported into the United States have begun to rise after declining on balance for several years, but the turnaround to date has been mild. Apparently, foreign exporters have been willing to absorb some of the price decline measured in their own currencies and the consequent squeeze on profit margins it entails.

Part of exporters' losses, however, have apparently been offset by short forward positions against the dollar in foreign exchange markets. A marked increase in foreign exchange derivative trading, especially in dollar-euro, is consistent with significant hedging of exports to the United States and to other markets that use currencies tied to the U.S. dollar. However, most contracts are short-term because long-term hedging is expensive. Thus, although hedging may delay the adjustment, it cannot eliminate the consequences of exchange rate change. Accordingly, the currency depreciation that we have experienced of late should eventually help to contain our current account deficit as foreign producers export less to the United States. On the other side of the ledger, the current account should improve as U.S. firms find the export market more receptive.


* * *
Although the prospects for the U.S. economy look quite favorable, we need to remind ourselves that all forecasts are projections into an uncertain future. The fact that most professional forecasters perceive much the same benign short-term outlook that is our most likely expectation provides scant comfort. When the future surprises, history tells us, it often surprises us all. We must, as a consequence, remain alert to risks that could threaten the sustainability of the expansion.

Besides the chronic concern about a sharp spike in oil or natural gas prices, a number of risks can be identified. Of particular importance to monetary policy makers is the possibility that our stance could become improperly calibrated to evolving economic developments. To be sure, the Federal Open Market Committee's current judgment is that its accommodative posture is appropriate to foster sustainable expansion of economic activity. But the evidence indicates clearly that such a policy stance will not be compatible indefinitely with price stability and sustainable growth; the real federal funds rate will eventually need to rise toward a more neutral level. However, with inflation very low and substantial slack in the economy, the Federal Reserve can be patient in removing its current policy accommodation.

In the process of assessing risk, we monitor a broad range of economic and financial indicators. Included in this group are a number of measures of liquidity and credit creation in the economy. By most standard measures, aggregate liquidity does not appear excessive. The monetary aggregate M2 expanded only 5-1/4 percent during 2003, somewhat less than nominal GDP, and actually contracted during the fourth quarter. The growth of nonfederal debt, at 7-3/4 percent, was relatively brisk in 2003. However, a significant portion of that growth was associated with the record turnover of existing homes and the high level of cash-out refinancing, which are not expected to continue at their recent pace. A narrower measure, that of credit held by banks, also grew only moderately in 2003. All told, our accommodative monetary policy stance to date does not seem to have generated excessive volumes of liquidity or credit.

That said, as we evaluate the risks to the economy, we also assess developments in financial markets. Broad measures of equity prices rose 25 percent in 2003, and technology stocks increased twice as quickly. The rally has extended into this year. And as I noted previously, credit spreads on corporate bonds have narrowed considerably, particularly for speculative-grade issues. This performance of financial markets importantly reflects investors' response to robust earnings growth and the repair of business balance sheets over the past few years. However, history shows that pricing financial assets appropriately in real time can be extremely difficult and that, even in a seemingly benign economic environment, risks remain.

The outlook for the federal budget deficit is another critical issue for policymakers in assessing our intermediate- and long-run growth prospects and the risks to those prospects. As you are well aware, after a brief period of unified budget surpluses around the beginning of this decade, the federal budget has reverted to deficits. The unified deficit swelled to $375 billion in fiscal 2003 and appears to be widening considerably further in the current fiscal year. In part, these deficits are a result of the economic downturn and the period of slower growth that we recently experienced, as well as the earlier decline in equity prices. The deficits also reflect fiscal actions specifically intended to provide stimulus to the economy, a significant step-up in spending for national security, and a tendency toward diminished restraint on discretionary spending. Of course, as economic activity continues to expand, tax revenues should strengthen and the deficit will tend to narrow, all else being equal. But even budget projections that attempt to take such business-cycle influences into account, such as those from the Congressional Budget Office and the Office of Management and Budget, indicate that very sizable deficits are in prospect in the years to come.

As I have noted before, the debate over budget priorities appears to be between those advocating additional tax cuts and those advocating increased spending. Although some stirrings in recent weeks in the Congress and elsewhere have been directed at actions that would lower forthcoming deficits, to date no effective constituency has offered programs to balance the budget. One critical element--present in the 1990s but now absent--is a framework of procedural rules to help fiscal policy makers make the difficult decisions that are required to forge a better fiscal balance.

The imbalance in the federal budgetary situation, unless addressed soon, will pose serious longer-term fiscal difficulties. Our demographics--especially the retirement of the baby-boom generation beginning in just a few years--mean that the ratio of workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability in coming years to provide even minimal government services while maintaining entitlement benefits at their current level, without debilitating increases in tax rates. The longer we wait before addressing these imbalances, the more wrenching the fiscal adjustment ultimately will be.

The fiscal issues that we face pose long-term challenges, but federal budget deficits could cause difficulties even in the relatively near term. Long-term interest rates reflect not only the balance between the current demand for, and current supply of, credit, they also incorporate markets' expectations of those balances in the future. As a consequence, should investors become significantly more doubtful that the Congress will take the necessary fiscal measures, an appreciable backup in long-term interest rates is possible as prospects for outsized federal demands on national saving become more apparent. Such a development could constrain investment and other interest-sensitive spending and thus undermine the private capital formation that is a key element in our economy's growth prospects.

Addressing the federal budget deficit is even more important in view of the widening U.S. current account deficit. In 2003, the current account deficit reached $550 billion--about 5 percent of nominal GDP. The current account deficit and the federal budget deficit are related because the large federal dissaving represented by the budget deficit, together with relatively low rates of U.S. private saving, implies a need to attract saving from abroad to finance domestic private investment spending.

To date, the U.S. current account deficit has been financed with little difficulty. Although the foreign exchange value of the dollar has fallen over the past year, the decline generally has been gradual, and no material adverse side effects have been visible in U.S. capital markets. While demands for dollar-denominated assets by foreign private investors are off their record pace of mid-2003, such investors evidently continue to perceive the United States as an excellent place to invest, no doubt owing, in large part, to our vibrant market system and our economy's very strong productivity performance. Moreover, some governments have accumulated large amounts of dollar-denominated debt as a byproduct of resisting upward exchange rate adjustment.

Nonetheless, given the already-substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents. Taking steps to increase our national saving through fiscal action to lower federal budget deficits would help diminish the risks that a further reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth.

The large current account deficits and the associated substantial trade deficits pose another imperative--the need to maintain the degree of flexibility that has been so prominent a force for U.S. economic stability in recent years. The greatest current threat to that flexibility is protectionism, a danger that has become increasingly visible on today's landscape. Over the years, protected interests have often endeavored to stop in its tracks the process of unsettling economic change. Pitted against the powerful forces of market competition, virtually all such efforts have failed. The costs of any new protectionist initiatives, in the context of wide current account imbalances, could significantly erode the flexibility of the global economy. Consequently, creeping protectionism must be thwarted and reversed.


* * *
In summary, in recent years the U.S. economy has demonstrated considerable resilience to adversity. It has overcome significant shocks that, in the past, could have hobbled growth for a much longer period than they have in the current cycle. As I have noted previously, the U.S. economy has become far more flexible over the past two decades, and associated improvements have played a key role in lessening the effects of the recent adverse developments on our economy. Looking forward, the odds of sustained robust growth are good, although, as always, risks remain. The Congress can help foster sustainable expansion by taking steps to reduce federal budget deficits and thus contribute to national saving and by continuing to pursue opportunities to open markets and promote trade. For our part, the Federal Reserve intends to use its monetary tools to promote our goals of economic growth and maximum employment of our resources in an environment of effective price stability.

[squiffy]

First, Greenspan's public remarks are very different from his private thoughts. He must generally put a good face on things and not try to rile the markets, let alone influence elections.

Privately, he is quite upset about the budget deficits that Bush is running and I believe mentioned the budget deficit in his statements to Congress.

Secondly, Greenspan's comments are more a statement about what inflation has been and what inflation is. Not a definitive prediction about what inflation will be in the future.

Note the fed changed its language about holding short-term rates constant indefinitely to we can afford to be patient.

But rates will most certainly rise if the expansion continues.

He is, as always, basically non-committal. He will raise rates as necessary to combat inflation. No one is arguing with the truism that rates have been low and that at present they remain low, and that at present inflation is not a threat.

But once the expansion takes place, if it continues at its current rate, (particularly if it is accompanied by a worldwide economic expansion) rates will go up.

And even if the fed does not raise short-term rates, long term rates will rise. The fed does not control long-term rates. The market does.

Note that Greenspan does not say he won't raise rates until the year 2008. He makes no definitive prediction as to how long he will remain patient. Patient could mean one month, one year, or ten years.

Greenspan's statements are not necessarily an alternative viewpoint to Gross. Greenspan tries to stay factual and non-committal. He does not predict that rates will not rise. He provides no specific timeframe or clear prediction.

If you ask both Greenspan and Gross privately whether they think rates (short term and long term) will be higher in 2005 or 2006 than in 2003, they may both tell you, yes, it is more likely than not that rates will be higher in the future, assuming U.S. economic growth continues at its current pace.

Think about how subtle, tactful, and courtier-like Greenspan is. He is always indirect and understated. Remember Greenspan's comments about irrational exuberance on the stock market way back in Dec. 1996.

Even a tiny statement about the budget deficit shows the extent of his concern about its future effects on inflation. But he cannot come out publicly and say this too strongly, because he would be getting involved in a political decision which really is not his province, though the budget deficit certainly threatens to make his job of inflation fighting much more difficult in the future.

[adios]

Basically your statements are inline with what I projected regarding a flatter yield curve. Greenie didn't say there were no risks to the US economy and he sees price stability as an acheivable goal. The point I'm making is this, in order for inflation pressures to build in the economy you'll have to see a surge in the demand for labor. We haven't seen that surge and I suspect that we will not see substandard job growth in 2004. The figure I here and read is that the economy has to grow at 150,000 jobs a month to keep pace with the demands of the labor force for new jobs. The friggen economy grew at 6% in the second half of 2003 and couldn't maintain that pace. Business investment is on the rise which is the necessary ingrediant for economic growth so we'll see. I hope I'm wrong about the pace of new jobs being created in the economy.

Greenie's remarks about the budget deficit in his prepared statement are basically inline what he testified to in Congress. He did acknowledge that a slower economy has depressed government tax revenues. He also discussed the problems with entitlements and basically stated what I stated in one of my posts. I think your post is basically orthogonal to my post. What I quibble with is the certainty you have that inflationary pressures will substantially increase in 2004. I don't see that happending. Again that's what makes a market.

If you're concerned about budget deficits perhaps you'll be really concerned of one of these guys gets elected:

The Return of Fuzzy Math and Risky Schemes: How Presidential Hopefuls Would Deepen Deficits (http://www.ntu.org/main/press.php?PressID=548&org_name=NTUF)

A table of how much they would increase the current budget deficit by:

Table 1. New Spending Proposed by Democratic Presidential Candidates

Candidate
Total Proposed Spending Increase (Annual, in Billions)

Sharpton
$1,327.01

Kucinich
$1,060.35

Gephardt
$368.76

Kerry
$265.11

Dean
$222.9

Clark
$220.66

Edwards
$199.48

Lieberman
$169.55

Source: National Taxpayers Union Foundation calculations.



Well several are out of the race now and some never had a chance to begin with.

[squiffy]

As you said, we shall see. I don't have any problem believing that short term rates will stay low for as long as a year. But given the rapid growth we have been seeing, I find it hard to believe that it is realistic to assume that long-term rates will stay as low as they have for say, two, three, four, or five years into the future.

Ten years is a long, long time. And anyone buying 10 year bonds has got to be a little worried about the strong possibility of a rise sooner or later.

Yes, the jobless recovery seems to be one of the great economic mysteries of recent times. (Interesting how the economy keeps stumping the experts -- remember stagflation in the 1970s and early 1980s)

Two theories I have heard include the fact that we are outsourcing many jobs overseas -- manufacturing to China and Mexico and service and computer programming to India. In addition, there is the increasing productivity in the economy due to the introduction of the desktop computer, internet, and increasing computerization of society.
One thing I have not heard mentioned are the obvious effects of Sept. 11, which fundamentally changed the amount of airline travel people have done, which has severely affected the economy.

But there have been many offsetting factors, including car sales and home sales. And those purchases will bring increased spending for repairs and upkeep.

And what people overlooks is America's growing interdependence on the growth of the world economy. If China, Japan, and Europe grow, then America will benefit from increased world trade, and increased world demand for oil, natural resources, and finished goods will increase prices.

To give a stock market example, when ODP is at 5 or 10, unless you assume it is going bankrupt, then it makes sense to predict that in the future, the price will be higher, say 15, or 17, based on historical cycles.

That is my same argument with long term rates. Rates and economic growth tend to be cyclical. If we were in the middle of a recession, it makes sense to predict higher growth in the future.

And if we have the lowest interest rates in 20 or 30 years, it makes sense to predict higher rates.

Similarly, if Amazon is at 700 and has never made a profit, and has been exploding beyond belief during a period of irrational exuberance, it makes sense to presume that in 1 or 2 years, it is very likely it will be lower.

[adios]

I went back to 1962 and did a comparison of 10 year Treasury yields vs. inflation as measured by changes in the CPI. The average spread was 2.72 percent. At the current 10 year yield the bond market is predicting an inflation rate of between 1.3% and 1.6%. It should be noted that the spread has narrowed since 2000. I haven't done a lot of other analysis on the data. Using an inflation rate of 3.5% which some say is the long term inflation rate, The 10 year would back up to about 7.2%. My crystal ball doesn't go out too far past 1 year and I'd say if we see inflation at something between 2% and 3% for 2004, I could see the 10 year backing up to between 5% and 5.5%. I predict that these rates would not kill earnings for the mortgage companies. I'll publish the table but it doesn't come out well here.

Year 10Yield Infltn Spread
1962 4.06 1 3.06
1963 3.82 1.3 2.52
1964 4.14 1.3 2.84
1965 4.2 1.6 2.6
1966 4.63 2.9 1.73
1967 4.69 3.1 1.59
1968 5.63 4.2 1.43
1969 6.04 5.5 0.54
1970 7.86 5.7 2.16
1971 6.46 4.4 2.06
1972 5.94 3.2 2.74
1973 6.43 6.2 0.23
1974 6.94 11 -4.06
1975 7.42 9.1 -1.68
1976 7.77 5.8 1.97
1977 6.84 6.5 0.34
1978 7.83 7.6 0.23
1979 9.18 11.3 -2.12
1980 10.5 13.5 -3
1981 12.42 10.3 2.12
1982 14.19 6.2 7.99
1983 10.32 3.2 7.12
1984 11.86 4.3 7.56
1985 11.7 3.6 8.1
1986 9.04 1.9 7.14
1987 7.18 3.6 3.58
1988 8.83 4.1 4.73
1989 9.23 4.8 4.43
1990 7.94 5.4 2.54
1991 7.97 4.2 3.77
1992 6.78 3 3.78
1993 6.6 3 3.6
1994 5.92 2.6 3.32
1995 7.88 2.8 5.08
1996 5.6 2.9 2.7
1997 6.54 2.3 4.24
1998 5.67 1.6 4.07
1909 4.69 2.2 2.49
2000 6.58 3.4 3.18
2001 4.92 2.8 2.12
2002 5.2 1.6 3.6
2003 4.07 2.2 1.87
2004 4.38 1.9 2.48

[AceHigh]

[ QUOTE ]
If you're concerned about budget deficits perhaps you'll be really concerned of one of these guys gets elected

[/ QUOTE ]

They can't increase the budget deficits any more or faster than Bush. They almost have to be more fiscally balanced than Bush.

[Wildbill]

First off I think people are making a mistake here. I don't think Greenspan can or even thinks he can truly control inflation. He can direct it in certain ways and he surely can call it out if he wanted to inflate the economy more, but bottom line is the short term rates are very slight movers of inflation. Inflation is about market-wide perceptions that manifest themselves in really big dollar movements. The market generally views inflation as likely to come back soon, due to the recovering economy. But the thing seems to be those with even bigger money are either willing to bet against it or just don't have a choice. I kind of think the latter is the case here. China and Japan are sitting on a ton of dollars right now. Literally sitting on them, they absorbed them and they sit. That is money that could cause major inflation if it quickly hit American shores. Seems clear though that China and Japan have no intentions of doing that. So while the world might think that inflation is inevitable, as long as foreign central banks are taking that money off the table, it really is hard for it to come to fruition. Maybe the Europeans and some hedge funds are betting that way and they do control a lot of money, but all of them are out of their league compared to what two central banks are doing. The reason being those moving the dollar right now and possibly with it the expectations of inflation are just merely making a guess at it and of course will always float to the best investments. The two central banks are doing their thing as a matter of economic policy, damn the immediate returns.

My guess is that inflation hits the US pretty hard in the next 3-5 years when China overheats and then collapses temporarily as a result. The Chinese government will need to quickly sell off those dollars at some point to offset the aversion to Chinese investments that would result from that. In tandem Japan will have less pressure to absorb so much of a currency it can't really put to use.

[SossMan]

Adios,
I think that anything coming from the NTUF should have an asterik. This is the same organization that has, for 25 years, concluded that the answer to any economic problem is to cut taxes and spending. I don't care how conservative you are, you have to take these things w/ a grain of salt. Defificts = Spending - Taxes Collected
If you increase the taxes collected (i.e. repeal the Bush Tax Cuts)
then you can increase spending without necessarily increasing deficits. To say that these candidates will increase budget deficits because they plan on increasing spending is only telling half the story.
And please don't try to sell me on the old "tax cuts actually create MORE tax receipts than tax increases". It has been pretty much discredited by most serious economist that we are on a point above maximum receipts on the Laffer curve.
In short, it would be difficult for a new president to increase the budget deficit by more than Bush has in just 3.5 years (from ~260B surplus to ~550B deficit).

[GeorgeF]

1) Pimco created a new high fee fund PCRAX which invests in commodities, he has been peddling it on Barrons and elsewhere.

2) Van Hoisington is the last of the bond bulls. Their fund is WHOSX. They are unconcerned by the US$ and inflation. Their thoughts:
http://www.hoisingtonmgt.com/hoisington_economic_overview.htm

[adios]

[ QUOTE ]
Defificts = Spending - Taxes Collected

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Ok I challenge you to show me how adding in the Bush tax cuts will balance the budget. Also I challenge you to show me where any of the Democratic candidates have advocated spending cuts. The Bush tax cuts add up to about $135 billion. Kerry has stated that he'll increase the marginal rate on the highest bracket only. If elected and he's successful (a big if given the probable make up of Congress) that won't come anywhere close to $135 billion.


Over the past 24 years (the era of disinflation) the administration with the highest GDP growth is the Reagan administation, the administration that cut taxes the most. IMO if one wants to shrink the size of government one has to cut taxes then cut spending.

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If you increase the taxes collected (i.e. repeal the Bush Tax Cuts)
then you can increase spending without necessarily increasing deficits. To say that these candidates will increase budget deficits because they plan on increasing spending is only telling half the story.

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No the study takes into account what each candidate has proposed regarding how they'd modify the Bush tax cuts. Kerry for instance has stated that he'll only increase the highest marginal tax rate.

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And please don't try to sell me on the old "tax cuts actually create MORE tax receipts than tax increases". It has been pretty much discredited by most serious economist that we are on a point above maximum receipts on the Laffer curve.

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Why not? Do you have some data to validate your claim because I'd be interested in seeing it. If heard Laffer himself go on TV and state that more tax cuts would increase economic growth thus increase government revenues. Over the past 24 years (the era of disinflation) the administration with the highest GDP growth is the Reagan administation, the administration that cut taxes the most. IMO if one wants to shrink the size of government one has to cut taxes then cut spending.

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In short, it would be difficult for a new president to increase the budget deficit by more than Bush has in just 3.5 years (from ~260B surplus to ~550B deficit).

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Au contraire just watch what happens if Kerry gets elected and actually gets his programs adopted. If you look at federal government revenues, they declined for three straight years from 2000-2003. The only other the other time that this has happened since 1900 is from 1930-1933. There is no doubt that main contributing factor to the budget deficit is the most recent recession (including the stock market meltdown) and subsequent slow recovery. I've posted about the budget deficit in detail at various times in 2003. To summarize decrease revenues, increases in defense spending, non linear growth in medicare/medicaid have been shown the biggest increases in outlays. The budget deficit will be a continuing problem unless medicare/medicaid spending is reigned in and social security is reformed. Social security is the number one sacred cow in Congress. It's a flawed system that will cause huge deficits when the baby boomers reach retirement age unless it's reformed. Are you stating that increased taxes don't inhibit growth? We can discuss the causes of the last recession but I think putting the blame for the recession on Bush is totally misguided. I wouldn't put it on Clinton either BTW.

[adios]

Why is that? Show me where one of the Democratic candidates has advocated a spending cut on anything. The Bush tax cuts amount to about $135 billion dollars and if they don't stimulate growth by even one $0.01 which seems to be a popular viewpoint, there is no way that the budget will be balanced. Kerry has stated that he only wants to increase the highest marginal tax rate. Federal government revenues have declined precipitously since 2000 and the tax cuts simply don't add up to the difference. If you look at outlays you'll see that defense spending and non linear growth in medicare/medicaid spending are where the biggest increases in occurred. Federal government revenues peaked in 2000. Defense spending in the Clinton administration as a percentage of GDP hit lows not seen since immediately after World War II. I concede that at the time there seemed to be some justification for this (the peace dividend).

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You've posted this before. Interesting link. I think this data supports my claim that we'll see sluggish job growth in 2004 at best.

[AceHigh]

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Why is that? Show me where one of the Democratic candidates has advocated a spending cut

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Because politicians don't like to talk about tough choices like where to cut. They want easy choices, ones that everyone will like them for making.

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The Bush tax cuts amount to about $135 billion dollars and if they don't stimulate growth by even one $0.01 which seems to be a popular viewpoint

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It's not that they don't stimulate the economy, it's that the money is so small compared to whole economy. The US GDP is around 11-12 TRILLION dollars. The tax cuts are just too small compared to the whole economy to have the effect necessary to stimulate the country out of a downturn. Plus some of our tax cuts are going to other countries, like China (stupid PC's) or Germany (curse you BMW!).

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Defense spending in the Clinton administration as a percentage of GDP hit lows not seen since immediately after World War II. I concede that at the time there seemed to be some justification for this (the peace dividend).

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And this is where spending has mushroomed under Bush and will likely decrease under another president. Bush is spending large amounts on big ticket weapon systems that don't have much of a role in the war on terrorism or regional conflicts like Afghanistan and Iraq. For instance, he proposes 30-40% increases in the Missile Defense program. And he is budgeting for building a new attack submarine for the Navy. Bush has increased Defense spending for the new areas we need, like the war on terror, but hasn't tried to balance this by cutting areas we are less likely to need in future wars.

Hey who wouldn't love it if we could cut taxes, increase spending, create bigger deficits and have the economy grow enough to support it? Not me. But I think it's been proven that the US economy doesn't work the way Reagonimics hoped it would.

[Wildbill]

Sorry to break this to you, but under Reagan the taxation of the economy as a percentage of GDP didn't fall very much. Don't get caught up in the headlines of tax cut or tax increase, it is all political stuff. These tax "changes", a term I prefer to avoid the polarized political debate over them, are going to do very little for the deficit and tax burdens. The problem is spending and I think the Democrats are handing Bush a little victory by focusing on his tax cuts. Focus on the spending, especially the new programs that are saps to Republican donors and you will have a better, more reasonable argument. A tax "change" will be a symbolic first gesture that would be useful down the road, but it won't solve any big problems without other changes in spending and budgeting.

[adios]

Points well taken. But they did fall and the most important aspect in mind is the elimination of many of the marginal tax brackets. I realize that avoiding the polarized political debates is probably the wisest move. But in my mind there isn't shred of evidence that Kerry and/or Edwards will make any impact on the budget deficit. Rescinding the Bush tax cuts will not balance the budget or even close. IMO increasing taxes is a drag on economic growth. I think the headlines about the deficit lead to a lot of misguided discussion and debate if not outright hysteria. To avoid a polarized debate where is either party advocating spending cuts? If neither party is advocating spending cuts then which party is advocating the biggest net increases in government spending? If anyone has got some data I'd be more than greatful to see it When I go to the Kerry and Edwards web sites what they're proposing look an awful lot like increased expenditures and bigger government to me. I would be more than happy if someone could show me where I'm wrong. I challenge anyone to look at entitlements and tell me that there is not a serious problem there and that the budget deficit will decline in the long run without reforming them. I say the long run because Social Security is running at surplus now but it's a ticking time bomb. What's needed is a bi-partisan effort in my opinion to reform them. A pox on both parties if they continue the petty squabbles and political pandering and let this potential disaster happen.
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The problem is spending and I think the Democrats are handing Bush a little victory by focusing on his tax cuts. Focus on the spending, especially the new programs that are saps to Republican donors and you will have a better, more reasonable argument. A tax "change" will be a symbolic first gesture that would be useful down the road, but it won't solve any big problems without other changes in spending and budgeting.

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I couldn't agree with you more. Say something that followed the Reagan tax cuts, like Grahm-Rudman? I'll reiterate cut taxes, then cut spending not the other way around. Taxes have been cut and most aren't permanent either. Now it's time to cut spending.


A Digression

I guess it's obvious that my sentiments line up more with the Republicans than the Democrats but I consider myself someone in the "middle" and even could see myself voting for a Democrat for president. I just don't understand the anything but Bush strategy by the Democrats and the subsequent nastiness and divisiveness that I perceive. The Republicans are no better if and when they respond in kind. What good is it going to be if the Democrats get their guy in and totally alienate the Republicans (which they're doing btw)? Perhaps Edwards has the right message and will be able to do more consensus building if he wins the presidency. I see Kerry as a much more divisive candidate but could be convinced otherwise. To be honest what I see is that the Democrats have a much better chance of winning than what the current odds indicate. I think in Ohio, Pennsylvania, Michigan and Illonois Bush is in big trouble. Too many people have been hurt by this slowdown and continue to be hurting IMO. I think things are coming around but slowly, ever so slowly. I really, really hope I'm wrong about the jobs picture. It's not from the standpoint that it helps Bush either. If there was anyway a Democratic candidate could guarantee a lot more people going back to work at decent paying jobs in the private sector I'd gladly vote for that candidate. Please show me that Kerry and/or Edwards is that person.

[Wildbill]

I so object to your thinking on "tax increases". Such a nice political sham by Bush and his people. They make a budget and pass it with the concept that the tax cuts were temporary and would go back because the tax cuts were merely a way to jump start the economy. Now they say anyone who agreed to that exact deal is actually a supporter of tax increases? I say Republicans for pushing this line of thinking are flat out liars. They lied to the people with a straight face because we all heard the moment it passed many of them saying "well we did this because it was all we could do, but we will make these permanent because we won't raise people's taxes". Why don't we call these people what they are, a bold set of liars. Fine argue all you want about tax increases, but admit you are liars so the public will remember the next time they make some policy pronouncements that they are most likely only telling half the truth on it. Whats worse, they will turn around and try to take the high road and never admit they lied in the first place.

This attitude is EXACTLY what bothers me with this party now. It is brazen in its spin and vote buying. Tom DeLay may think he is leading some religious charge, but what he is leading is a charge of filthy politics with the motto "either you are 100% with us or you are a threat to the Republic". I have never been much of a fan of the Democrats, but times change and until Republicans start following more sensible and honest leaders, I refuse to support them. Not another vote, not another dime in contributions.