August 17, 2004


Inflation Puts on a Happy Face (The Street, 8/17/2004)

For the second time in less than a week, government inflation figures came in less than expected, a development that could take some of the pressure off of the Fed to raise interest rates for the third time in free months at its next monetary policy meeting in September.

The government Tuesday said consumer prices fell 0.1% in July, when economists were expecting a 0.2% increase, on top of June's 0.3% gain. It was the first decline in eight months.

Equally important, the core rate of retail inflation, which excludes energy and food costs, rose just 0.1%, matching June's increase, but less than economists' consensus forecast of 0.2%.

Crude Oil Falls Again (The Street, 8/17/2004)
Crude oil prices fell Tuesday for the second straight session, moving further from the record high set last Friday, but traders remained focused on volatile supply issues.

Daily Forex Commentary (Jack Crooks, 8/18/04, Asia Times)
Was last Friday’s dollar drubbing on the seemingly "devastating" report of the soaring US deficit a one-day wonder? Could it be that Friday’s move was based on false assumptions? I answer yes to both questions. If I am right, than Friday’s move was a gift to dollar buyers.

Morgan Stanley economist Stephen Jen writes in his recent economic notes: "Being the hegemonic currency of the world, the dollar enjoys 'special treatment' in asset markets." I agree. I recommend reading Mr. Jen’s analysis entitled: The Dollar is Special . I think it could be especially good reading for the perennial dollar bears in our midst.

The key points of the piece relate to why high US deficits can be maintained and not lead to a collapse in either the dollar or Treasury market:

1. The demand for dollars is rising as the world increasingly globalizes.
2. US indebtedness is not relatively as bad as pundits suggest.
3. The call for a US dollar crash means a Chinese RMB crash because of the linkage - Jen believes this will not happen.
4. The US dollar correction is complete. The next 10% move in EUR/USD, GBP/USD, and AUD/USD will be down.

I think Jen’s analysis and conclusions place him firmly in the dollar bull camp.

Another canard about the dollar has been bothering me - the linkage between US consumer indebtedness and a weaker dollar. One prominent analyst I will not name, in order to protect the guilty, continuously laments about the cocooning US consumer. But shouldn’t the US trade deficit be improving if Mr US Consumer was cocooning ie importing less?

Granted, the global economy either hit a rough patch or is in trouble based on the news that goods exports plunged by 5.9% in June (in real terms), the largest single monthly decline on record, according to Morgan Stanley. But again, I go back to the relative economic performance argument. If the US consumer is in such bad shape, why are we sucking in so many imports? Well, I don’t think the consumer is a bad off as the doom and gloom crowd would have us believe. And I think this is another reason why the relative strength of the US economy will surprise in the months ahead.

I took these tidbits of information from a recent column by Bloomberg financial writer Caroline Baum:

The decline in June retail sales was revised to down just 0.5% from the originally reported 1.1%. The debt service burden, or the ratio of debt payments to deposable personal income, has begun to ease, falling to 12.98% in the first quarter from an all-time high of 13.27% in the fourth quarter. The financial obligations ratio fell to a 3.5 year low of 18.09% in the first quarter of this year. (It is a broad measure of consumer indebtedness that includes auto lease and rental payments, homeowners insurance and property taxes in addition to mortgage and credit card debt.) Revised retail sales for July could be closer to 2%, compared to the 1% reported. Auto sales rose by 1.9 million units in July, as consumers are still responding to incentives. Record setting existing home sales of 6.95 million units in June will help drive durable and non-durable good purchases in the months to come. There has been no tightening of credit standards for consumer loans, according to a survey of senior loan analysts.

It’s tough to argue that the US consumer is either over indebted or going into hiding as you scroll through that list of facts.

Careful walking by tall buildings today, there'll be goldbugs leaping from ledges as the deflationary cycle reasserts itself.

Posted by Orrin Judd at August 17, 2004 9:10 AM

CPI was a bit of a surprise. Note that it is for July before oil prices spiked in August.
As I said in an earlier post I expect oil back down to $35/barrel or lower by October as fears over Chavez, Iraq, hurricanes, etc. dwindle. Also today there are stories the Saudies want the price below $30/barrel and will work on increasing supply to do so.

Posted by: AWW at August 17, 2004 9:31 AM

Regular unleaded was at $1.739 yesterday. The President's a genius.

Posted by: David Cohen at August 17, 2004 10:27 AM

I think the Dems are going to have to pay al-Qaeda to pop a nuke in one of our cities to torpedo the economy and put Kerry in the White House. (And who's to say they wouldn't? After all, The Cause justifies anything to bring it about...)

Posted by: Ken at August 17, 2004 12:43 PM


Watch the price of orange juice - it's going up, up, up! Those darn Bushes.....

Posted by: jim hamlen at August 17, 2004 3:15 PM

Actually, my wife was shocked by the price of butter this weekend. Land o' Lakes four packs were selling for $4.00.

Posted by: David Cohen at August 17, 2004 3:20 PM

Ken, I know you are being funny, but it worries me that there are a number of hugely rich guys like Soros etc. who seem to be willing to do or say anything to ensure Bush's defeat. Soros, of course, made a fortune with currency manipulation against the British pound. What's to stop him from coming up with some sort of October Surprise economic disaster for the US?

Posted by: PapayaSF at August 17, 2004 3:28 PM


We hope it would be a 9-mm headache.

Posted by: jim hamlen at August 17, 2004 4:10 PM

Gold is up over $400 again, you won't see any goldbugs leaping from windows. Gold trades inversely to the dollar, and the dollar is heading down again. You guys must have missed the news about the record trade deficit in June, the currency traders didn't.

Posted by: Robert Duquette at August 17, 2004 5:19 PM

You comment re: deflation is right on. 10 years from now, it will be obvious that, way back ion 2004, we were still in the early stages of a secular deflationary trend. It started with the Asian meltdown, and sidelined growth in Japan first; Greenspan's cheap money and Bush's tax cuts held prices more or less steady here, and secondarily in most western economies. There would be a downward trend in commoditiy indices today were it not for demand from China.

There will be a "correction" in China within the next few years, which, becuase they have only the crudest of capital markets, will quickly become a collapse. The regime's only claim to legitimacy, that it is improving the peoples standard of living (which is already qquestionable, given the growing disparity between urban and rural living standards), will be stripped away.

This will lead to a collpase in demand that will be both swifter and deeper than anyone has anticipated. Interest rates here will not be hihg enough to allow stimulus from the Fed, and deficits will still be too high to allow significant tax cuts. We will have deflation in the U.S. for the first time since the freat depression. We are not prepared for it.

Posted by: Dan at August 17, 2004 5:42 PM


Started with Volcker and Reagan, by driving up interest rates and breaking PATCO. Then with the initiation of free trade and the breaking of communism.

Posted by: oj at August 17, 2004 5:45 PM


I don't disagree that Volker nad Reagan broke the inflation cycle, but the first really massive bubble post Cold War was the Asian "Tiger" expansion. The Rubin Treasury Dept. and hte Fed did everything possible to "sterilize" the effect of that collapse from hurting our economy, thus the Clinton boom, which the Fed and the tax cuts cushioned. At some point, you can't get away from Andrew Mellon's answer to coming through a bad patch in the economy: Liquidate capital, liquidate farming, liquidate labor, etc. Or, as FDR did, have a World War. Keep your eye on China.

Posted by: Dan at August 17, 2004 6:00 PM


No, we're already in the middle of a long deflationary cycle and it appears more similar to that of the late 19th century--driven by technological change and globalization--than like the Depression--driven by bad Fed policy, tax hikes and protectionism.

Posted by: oj at August 17, 2004 6:09 PM


Technology change has been with us through up and down cycles since the second half of the 18th century. Yes, we've had a lot of it in the last 20 years, and yes, it can and naturally should lead to both growth and lower prices-- at a very moderate level.

But we've had a lot of bad policy in the lst 20 years, which can be summarized in one word. Bailouts. The Mexican bailout, when Volker took his foot off the iar hose, flooded the street with money and strted the Reagan boom, the Chrysler bailout, the East Asian bailout, the Russina bailout, the Long Term Capital bailout, and the Bush/Greenspan bailout of the bust.

All of these bailouts have been justified by what are essnetially economic "containment" argumnets. Going back to 1982, I can remember the Mexican bailout being justified by the argument that, evne though Mexico's political and economic system was hopelessly corrupt, if we stood by and watched it collapse, the consequences wouldn't be limited to Mexico. So, we did, and in the 90's we had to do it again.

The coming China implosion will be beyond the capacity of the developing world to contain. It will take a good while for it to sink in that our thinking we can overcome the natural business cycle, and avoid the costs of over expansion and taking on too much debt, is hubris. Before that lesson sinks in, I would suggest that it is more likely than not that we will see bad trade policy, bad Fed policy, bad fiscal policy, etc., as we try (the wrong way) to preserve prosperity in one country.

Posted by: Dan at August 17, 2004 6:49 PM


What is the worse that could happen to the US if China was to economically collapse?

Lower oil and steel prices don't seem particularly problematic, and it isn't as if they are buying a whole lot of our stuff.

The coming China explosion will be well within the devloped world's ability to put on disregard.

Posted by: Jeff Guinn at August 17, 2004 7:56 PM


$400! Wow, if it goes up 400% tomorrow it will be back where it was when this deflationary epoch started.

Posted by: oj at August 17, 2004 8:50 PM

Funny how you have to adjust the 1980 price of gold upward for comparison purposes to account for a period of deflation. Shouldn't you be adjusting it downward?

Funny how housing prices are rising in a deflationary environment.

Posted by: Robert Duquette at August 18, 2004 1:14 AM


Use absolute measures and it only has to go up 125% today. We have more and more people and not enough houses. If we could make the houses in China they'd have gone down too.

Posted by: oj at August 18, 2004 8:49 AM

Whatever your explanation for the increase in housing prices, it points to inflation, not deflation.

Posted by: Robert Duquette at August 18, 2004 10:55 AM


No it doesn't. It suggests that one item is scarce and therefore more expensive while everything else is getting cheaper.

Posted by: oj at August 18, 2004 11:27 AM

So energy, food, raw material and houses are getting more expensive, but cellphones, patio furniture, brokerage services and video rentals are getting cheaper, and that spells deflation. Now that you put it that way, I feel better.

Posted by: Robert Duquette at August 19, 2004 1:48 PM

If energy and raw material price increases mattered the finished products wouldn't be getting cheaper. Food isn't either. Housing goes up because we need more and have to pay Americans to build it.

Posted by: oj at August 19, 2004 1:53 PM

Once companies can no longer eat increased raw materials costs because they would go out of business if they did, the price of finished products will go up. Energy, food, and raw materials are going up, read the papers:

Posted by: Robert Duquette at August 19, 2004 3:38 PM


Posted by: oj at August 19, 2004 4:22 PM