Last week’s Federal Open Market Committee (FOMC) meeting produced, what may be a first since the U.S. economy went into a recovery; admission by Federal Reserve members that the recovery is coming along more slowly than expected.
That notion was further confirmed by May retail sales numbers, which showed a -0.2 percent decline in spending, all but wiping out the 0.3 percent gain registered in April. Furthermore, unemployment has essentially been net zero in the first half of 2011 as continuing claims still hover near 3.7 million month after month.
These are items that we are all generally aware of by now, and I am not looking to harp on them. What is much more important is to take a look at the actions taken by the Federal Reserve and the expected outcomes from those actions.
To do so, I’d like to review a few statements made by Fed Chairman Ben Bernanke and how those beliefs have translated into the economy thus far.
In November 2002, Bernanke was a member of the Federal Reserve Board of Governors (he was elected Chairman in 2005). At that time he gave a speech entitled: “Deflation: Making Sure It Doesn’t Happen Here.” In that speech, Bernanke made a very clear statement that the central bank (Federal Reserve) “should always be able to generate increased nominal spending and inflation even when the short-term nominal rate is zero.”
So with that being said, when the economy falters the Fed can lower interest rates or increase the money supply or help finance increased government expenditures, etc. in order to stimulate spending and inflation in the economy. Fundamentally, this is a good thing.
However, we also need to be aware that there is a risk/reward to just about anything economics. The reward is increased spending and inflation, which spurs economic growth and prevents deflation, which nobody wants to see, trust me. The risk is that all of these actions don’t spur much of a spending increase and inflation runs stronger than desired, which would only further hurt spending as the cost of everything goes up, thus leading to weaker employment and so on.
In December 2002, Bernanke stated in an interview: “We’ve been very, very clear that we will not allow inflation to rise above 2 percent.” Now, let’s say inflation did rise above 2 percent, well, than the Fed would just raise interest rates to bring inflation down to an acceptable level.
My two concerns with this are:
The May Consumer Price Index (CPI) reported on June 15 was 0.2 percent, which works out to 2.4 percent annual inflation, so we are above the 2 percent threshold (and have been for several months now). Yet interest rates still sit a near zero percent and QE2 doesn’t conclude for another week (quantitative easing stimulates inflation, see my earlier newsletters for a full description of this).
Consumer spending is not showing any kind of sustained growth despite all of the Fed’s tools to stimulate the economy. Monthly spending results have been volatile all year with a strong monthly gain being followed by a decline, not exactly a sign of growing stability.
I’m not going to preach to you in this letter whether the Fed’s actions are right or wrong and if I am worried that inflation is going to get away from the central bank (though I think it’s only a matter of time), but rather display these items so you may stay informed, formulate your own opinion and best adjust your portfolio to weather to outcome.
Your still staying long inflation safe-haven investments analyst,
Mitch Jaworksi