The tax cuts and “elevated asset prices.”
Another rate hike is baked in for the Fed’s meeting next week, which will lift the target for the federal funds rate to a range between 1.25% and 1.50%. “A majority” of economists now expect three rate hikes in 2018, up from two rate hikes just a few weeks ago, Reuters said this morning, based on its poll conducted just before the Senate passed the tax cuts.
The tax cuts are making economists rethink what the Fed will do next year. According to Reuters, “the forecast risks have shifted toward higher rates, and faster.”
But are expectations still too low? Could an increasingly hawkish Fed surprise the markets with more rate hikes?
The three rate hikes next year that economists are now expecting just put them in line with the Fed’s own projections, published well before the tax cuts had become a nearly sure thing.
“This is about just getting back to a neutral level where monetary policy is neither encouraging growth nor pushing against growth,” Brett Ryan, senior US economist at Deutsche Bank, told Reuters. The bank now is expecting four rate hikes in 2018.
“The Fed is still accommodative at the moment and we are still some ways away from the neutral fed funds rate which would in the Fed’s view be closer to 2.75%,” he said. “The Fed can hike without slowing the economy.”
What has been seeping through the Fed’s communications all year is a concern over “elevated asset prices” and that, despite the Fed’s effort to “remove accommodation,” financial conditions in the markets have not tightened.
The dollar has fallen since the rate hike a year ago, stock prices have soared, bond prices have risen, and therefore yields have fallen, including junk bond yields — signs that investors are more and more chasing after higher and higher risks. This is the definition of loosening financial conditions, the opposite of what the Fed has set out to accomplish over the past year.
Where rate hikes have become effective is with yields at the shorter end of the curve – debt with maturities of up to two years. Those yields have risen sharply, and prices have come down. But these moves have not filtered into the rest of the markets.
Inflated asset prices – and what they could do to the economy when they suffer “a sharp reversal” – made their way once again into the Fed’s communications, this time into the minutes of the last FOMC meeting:
In light of elevated asset valuations and low financial market volatility, several participants expressed concerns about a potential buildup of financial imbalances. They worried that a sharp reversal in asset prices could have damaging effects on the economy.
National Bank of Canada’s Economics and Strategy came out with a note this morning, warning that economists and the markets might be underestimating the hawkishness of the Fed next year:
Even considering the low rate of U.S. inflation, monetary policy in the world’s largest economy is arguably too loose. It’s the first time since the 1970s that real interest rates are in negative territory despite a positive output gap. Some Fed members are now even expressing concerns about financial imbalances fearing “a sharp reversal in asset prices” according to the latest minutes. Recently approved tax cuts by Congress also warrant normalizing monetary policy. As such, we believe the Federal Reserve will raise interest rates more than what markets are currently expecting in 2018.
“Markets just don’t believe the Fed can significantly tighten monetary policy,” the team, led by Stéfane Marion, Chief Economist and Strategist, wrote in the note:
The fed funds rate is expected to be below 2% by the end of 2020, in sharp contrast to the Fed’s own view that rates will be closer to 3% by then. This market view has no doubt been shaped by years of disappointing readings on both wage growth and the overall inflation rate which have seemingly eroded trust in the Fed’s ability to hit its 2% inflation target.
Both, Janet Yellen and Jerome Powell, who will succeed her in February, have been on the same page, emphasizing over and over again that the Fed should continue the “gradual” process of normalizing monetary policy.
Normalizing monetary policy is a rubbery concept. A number of Fed governors have suggested that the “neutral” rate would be around 2.5%. Deutsche Bank above said it would be “closer to 2.75%.” “Neutral” means that the “accommodation” of the past nine years has been “removed,” as the Fed likes to phrase it. Any actual tightening of monetary policy would start at that point. But for now the entire conversation is about “removing accommodation.”
And the tax cuts are adding fuel to the brush fires that the Fed is trying to step out. The Fed’s projection of three more hikes next year didn’t take into account any potential tax cuts. A little over a year ago, the Fed stopped flip-flopping and has since done everything it said it would do, including the QE unwind that commenced in October. But markets have simply brushed off the Fed. This might set the scene for these willfully blind markets to get tripped up by a hawkish “surprise” next year.
Even as lawmakers cobbled together a tax-cut bill that would cut revenues by about $1.5 trillion over ten years, the gross national debt has spiked $723 billion over the past 12 weeks, to 105% of GDP. Read… US Gross National Debt Jumps $723 billion in 12 Weeks, Yellen “Very Worried about Sustainability of US Debt Trajectory”
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
My opinion is they will be Dovish. The current owner of the #BigFatUglyBubble is going to try his best to keep it inflated. This is why Yellen is out.
I don’t think he wants to be left holding nothing more that Janet Yellen’s flatulence.
Or maybe Yellen stepping aside is a good way to diffuse culpability, if the Fed seers discern an impending pop.
Greenspan can say he never could have anticipated today’s circumstances.
Bernanke can say he did what was necessary to save the world.
Yellen can say she put us back on the prudent path of ‘normalization’.
And now Powell can say that none it was his fault.
The “Fed” bankster cartel, which is misleadingly named the “Federal” Reserve, as if it were a genuine government agency, has been gutting the U.S. for years, by taking the credit of the U.S. and using it to push money to its corrupt, insolvent banksters. E.g., it has given super low interest loans to banks that were insolvent when those banks owed billions and would otherwise have become the property of their creditors through a Chapter 11.
It has also paid the same banksters huge commissions, when those commissions could have been negotiated way down, for the QE purchases of treasuries. Now, the Republican Congress (and the orange lying fool) is competing with them to see which is more reckless, corrupt, and irresponsible.
It is exploding the deficit via its reckless, deceitfully misrepresented tax cut, which is really a tax increase on the middle class scheduled to take effect years from now. We are now in between the bankster crooks and the corrupt Republicans, not to mention Republicrats like Dianne Feinstein, who are all struggling to see who gets the most “benefit” out of the U.S. government before its credit rating becomes as good as the Venezuelan government’s credit rating.
In other words, the rats are now in charge of the U.S. ship of state. Good help America.
re: tax cuts
When I model the published 2017 IRS tax tables, and 2018 house & Senate proposed tax tables, I can see very modest individual tax cuts (larger reduction % at taxable income < $75,000).
The difficulty I'm having is calculating "taxable income" – the House/Senate tax changes dramatically increase to the standard deduction and eliminate most deductions except mortgage interest, property tax, charity, some medical. This ought to make filing taxes easier.
On the other hand, the business tax changes are more significant (businesses really don't pay taxes, consumers and shareholders do). Simplified business taxes should reduce the need for armies of high-paid CPAs & lawyers to wiggle around loop-holes.
“businesses really don’t pay taxes, consumers and shareholders do”
I call BS. Business income taxes are paid on profit, not revenue. Customers pay the same whether the business makes a profit or not and regardless of taxes. Pricing policies are made of the basis of sales expectations, not income taxes, if any. Investors are paying for the expectation of future returns, not past returns, and pay regardless of profit, if any.
Yours is a logically fallacious argument for reducing business taxes in the service of corporate greed and has been debunked many times.
Agreed. Chip makes the assumption that businesses can set their prices without concerns about the effects on demand. Monopolies of products with inelastic demand can to some degree, but that is a small part of the world.
I think it is a pretty effective propaganda point for the corporatists however.
You could say that corporations ultimately shoulder the burden of corporate tax increases because consumers have a fixed income to spend. If the corporations try to pass on corporate tax increases to consumers via increased product price, the businesses sell less product to consumers. Therefore, corporations must eat the tax.
If corporate profit margins are very high like they are today, competition will also prevent corporations from passing on tax increases.
Nonsense. A 99% tax would have a very different effect than a 1% tax.
I didn’t say or advocate that businesses shouldn’t pay taxes, I simply stated an economic fact: only end-consumers & shareholders pay the tax . Product pricing incorporates everything a profitable business does, including taxes and reasonable return on investment.
Only customers and shareholders can possibly fund businesses (consumers by paying for products, shareholders by demanding more or less return on investment). Who do you think pays for them – the tooth fairy?
Walter can call BS all he wants – but it doesn’t change the fact that only consumers & shareholders pay business taxes.
The points I made discredit your argument, and you did not and cannot refute them. You also dance poorly.
“Walter can call BS all he wants – but it doesn’t change the fact that only consumers & shareholders pay business taxes.”
You’re wrong. Majority of studies agree. Shareholders, yes. Management, yes. Employees, yes.
Consumers? No, not really.
Taxes are paid on profits. A company does not know its profits until the end of the year. How could it possibly set prices based on taxes when it won’t know how that will affect profits? It’s not like taxes go up 10% so they raise prices 10%– prices are already at their theoretical max that balances market share.
Don’t take my word for it, though. Go do some research… it’s pretty much unanimous. Shareholders end up holding the bag more than anyone else, usually.
Speaking as a retired corporate CFO, actually no business knows exactly what they will be paying for anything a year in advance. Expenses (including taxes) are estimated and managed using experience and guesswork (some are based on long-term contracts (usually adjusted for unknown inflation).
So, at the end of the day, taxes on profits are indeed factored in as one of the cost components (try running a business without paying them). Taxes are seldom the largest expense line item, but if your business runs a 10% pre-tax margin, your (current) fed taxes will be about 3.5% of revenue. That’s too big a number to just “wait until the end of the year”.
I understand a business cannot set prices in a vacuum (markets do that), but taxes do have to fit under the pricing umbrella, and 3.5% of revenue is not an insignificant consideration.
smingles, we finally agree on something.
Also, I shudder to think of how the market will react when and if the Fed normalizes interest rates to approximate history. I can already hear the painful shrill shrieks more piercing than a baby on an airplane: “You can’t do that. You can only have normalized rates if you have inflation. Without inflation, interest rates need to be low or negative. Fed, how dare you!”
You are correct. The tax cuts will be used to fund stock buybacks by CEOs in the exercise of their stock options and what’s left will go to shareholders dividends.
The Republican tax bill will have a negative impact on Republicans up for re-election in 1918. Trump commented during his campaign that the stock market was a “big fat ugly bubble,” and now he prides himself on increasing the size of the bubble. Will he blame himself when the bubble implodes????
There are some tax plan calculators out there, for the new tax plan, if you want to try them. Open them in a private window, just in case, I tried taxplancalculator.com.
“How can taxes go up between 50-75K when they get an automatic 12/24K deduction ”
Correction.. the standard deduction goes up . Whereas many if not most of their itemized reductions have been either vastly reduced or eliminated completely .
And then there’s all the side bars that are attached to the new tax code that will directly impact what the tax payer will pay
e,g, One must look at the overall context and picture rather than focusing on one single aspect in order to discern the realities of the proposed tax code
( resource ; My CPA – a retired senior IRS agent still consulting/contracting on a regular basis for the IRS therefore having direct access to the proposed tax code itself rather than what any of the press ( on either ) side is saying about it )
The Feds cannot become hawkish next year. On the one hand wages are still very low and not rising. Everything is going up—rents, gasoline etc. Secondly, the new tax bill will leave the poor and middle class with higher everything else. Even WalMart is changing their stores to cater to the wealthier. Medicare, SocSec, Medicaid are next on the chopping block, so the poor, the retirees are going to be in a world of hurt.Former students with high debt will not be able to deduct this expense. SALT will wither higher taxpayers free cash flow.
The Fed said they worry about the trillions in federal debt, but congress doesn’t care so the Fed will have to curtail rates.
Dr. Pangloss, Voltaire would agree with you that it’s satirical, upside down world, where nothing makes any sense.
It is maddening to me as a lifelong Republican (with a liberal bent) that the GOP wants to ADD to the deficit knowing they are totally wrong at this time. I do not need nor desire a tax-cut. I am doing well. Attack the deficit which is why I voted for the people that I did.
This year is maddening, nutso, upside down etcetcetc.
Maybe this is all a Dream??
The hyperrich bought up the government so it could plunder the treasury, answerable only to other likeminded pirates. Now that the impediments have been removed they should be able to transform the country into a very large and very heavily militarized version of Haiti in no time.
Nobody in govt gives a damn about the debt, that’s why it’s 20T and rising. The new tax bill gives us at least an extra $100 a month and I have big plans for it, so speak for yourself. I may keep my cable on.
Dr Pangloss & Walter
Have either of you guys looked at what the (currently proposed Senate) tax cuts actually look like? I have, and at the following TAXABLE incomes, these are the % tax reductions (compared to 2017 IRS tables):
$25,000 – tax cut of 14.4%
$50,000 – cut 15.1%
$75,000 – cut of 10.3%
$100,000 – cut of 8.3%
$150,000 – cut of 9.2%
$250,000 – cut of 2.9%
$350,000 – increase of 0.1%
$450,000 – cut of 0%
$1,000,000 – cut of 2.2%
$5,000,000 – cut of 2.7%
I’m having a hard time seeing the injustice.
There is an alternative solution: flat tax, no tax credits.
As for the ballooning deficit? There is so much of it that it’s beyond comprehension, so we are just fumbling towards the Big Reset.
Voters care about after tax income.
Business owners care about after tax profit.
Politicians care about votes.
Nobody cares about the “system they are part of” as long as I can transfer some from the system into my pocket.
There is no principle, just individual interest.
The thing is, it takes time to screw up the eco-system so let’s drain the water up and eat all the fish and leaves our children and grand children to think about what to eat.
Trump holds his ground of his voter base and screws the voters of california and new york. The coast “deserves” it since they vote against me. I know how to win, and since I am a business man, I will make business tax cut “permanent” and by the time my voter base realizes not only their tax cut expires, but also they have to pay for the accumulated deficit, I will be long gone from the office and enjoy running my business. Those voters who enjoyed some Netflix will face inflation, medical, and tuitions.
Who cares about the economy, let’s grab power back from the career politicians like Obama or Clintons and return it to the hands of TRUE business owners.
It’s OK Dr,as a Conservative myself i cringe at ANYTHING that comes out of Washington DC these days,no matter what party. my first instinct is that i am being screwed without being taken out for dinner first,not even a kiss!
I see the crocodile tears. Most (if not all) ills you point to get washed away with a doubling of the standard deduction from $6,000 to $12,000.
Whether or not the tax bill passes, gas & rent are going to go up.
The effect of eliminating SALT removes the subsidy (tax deduction) high-tax state taxpayers have received. If citizens in state X want higher-price government services (taxes), that’s fine with me – but why should federal taxpayers be expected to subsidize that activity?
“If citizens in state X want higher-price government services (taxes), that’s fine with me – but why should federal taxpayers be expected to subsidize that activity?”
OK, take away the SALT and then mandate that states can no longer receive more in Federal spending than they generate in revenue and then come back to me with a straight face and talk about taxpayers subsidizing activity.
The whole south would have to raise taxes dramatically in order to offset the massive wealth transfers from blue states to red states. Military bases, food stamps, welfare… all gifts of the Federal government to Republican states courtesy of New England and California.
CA, with 12% of US population, has 34% of USA welfare recipients (http://www.sandiegouniontribune.com/news/politics/sdut-welfare-capital-of-the-us-2012jul28-htmlstory.html).
CA receives huge “subsidy” if that’s the way you want to look at it) from defense spending (contractors & active -duty).
Your using a tired argument of a deeply flawed study. By the way, most if not a good part of the salaries paid, are paid to soldiers who come from the coasts. Being that personnel is the biggest military cost, you should be a bit more careful with your descriptions there.
Does that study you cite include the welfare called QE that primarily benefited those who live in the ivory towers of CA, NY, and Seattle? These types generally don’t live in the South
People act like SALT prevents a double tax but no one forced to take the standard deduction today gets that tax break.
It was mostly home owners itimizing.
That likely being the case I wouldn’t be too concerned that a sudden double taxation is going to cripple people.
Hell they are taking the cap off the child deduction so that’s not bad. If you want to be pissed wait till they mess with SS or Medicare to pay for this shit even though there will be no change in payroll tax…
He’s absolutely correct.
Blue states, on average, send more than $1 to the Federal government in taxes for every dollar they receive back in benefits. They are net makers. Red states, on average, send less than $1 to the Federal government in taxes for every dollar they receive back in benefits. They are net takers.
South Carolina’s the biggest welfare queen of them all: it receives almost $8 in benefits from Washington every dollar paid to Washington.
chip javert – Where pray tell are you getting your numbers from ?
Here’s the simple reality ;
$101k plus ( my bracket ) – taxes decrease – ( with taxes decreasing exponentially the more you make )
$100,001 – $100,999 – taxes remain essentially the same
$100k and below – taxes increase – ( with the largest increase happening between $50k and $75k )
Thats where the injustice is . Capice’ ?
How can taxes go up between 50-75K when they get an automatic 12/24K deduction. I know people who make this and they are getting a big break. When they add in not paying the healthcare mandate, they are getting back thousands.
re my tax bracket calculations – I’m not trying to do anything fancy here:
1) I assumed various levels of “taxable income” (always less than “gross income”) , and I freely admit this was problematic due to increasing standard deductions & eliminating most deductions.
2) I took the 2017 IRS tax/brackets and the Senate version of 2018 tax /brackets, and simply ran “Taxable income” thru both calculations.
RESULT: for $100,000 of TAXABLE income @ 2017 IRS rates produced a tax of $20,982; proposed Senate 2018 brackets/rates produced a tax of $19,246 = tax reduction of 8.3%.
RESULT: for $50,000 of TAXABLE income at 2017 IRS rates produced a tax of $8,230; proposed Senate 2018 brackets/rates produced a tax of $6,996 = tax reduction of 15.1%.
CAVEAT: given 80% of incomes $25,000-$50,000 claim the standard deduction, a single person would need a GROSS income of about $62,000 to have a TAXABLE income of %50,000. Part of the problem here may be confusing TAXABLE and GROSS income.
Please advise if you spot an error in my process.
Well, I think the issue is that the “Taxable” income is likely to increase. I mean, anyone living in a Blue state making toward the middle of the income/tax ranges that you’d laid out above will have increased taxable income due to elimination of SALT.
For example, I live in Minnesota. Just because of the state income tax of 7.5% (on average) the new $12k individual exemption equates to the itemized state income tax + personal exemption of a taxable income of $106,000. This doesn’t include other deductions that ostensibly won’t be able to be taken, such as property taxes or mortgage interest deduction (because after the elimination of state Income tax deductability and elimination of the personal exemption, property tax + mortgage interest would need to exceed the $12k exemption, in order to be taken) that in the past would’ve been added to the now removed state income tax and personal exemption. (and taxes are higher in other states).
The effect is that a huge swath of people, particularly in the middle of the income ranges that you’ve outlined (kind of that 80k-200k, if I’m remembering it correctly from above) end up with a taxable income higher than can be made up for by the tax rate/bracket changes.
You can even look at the proposed numbers:
In particular, this table:
Just go down the list at the proposed costs/savings from the likely reconciled bills (leaving out smaller items or items that are unlikely to apply to most people (estate tax, inflation changes, ACA penalties, etc):
Individual tax rates -1174 billion
AMT changes -770 billion
Standard Ded. -737 billion
Child tax cr. -580 billion
Per exempt +1221 billion
Itemized ded. +829 billion
So if you’re an “average” person who doesn’t hit AMT (-770), Doesn’t take the standard deduction (ie used to itemize) (-737), doesn’t take kid credit (-580). Then the “average” person will experience an increase : -1174 + 1221 + 829 = +876 billion! (and then you might have to add back something from the ‘standard deduction’ part that you’d now be taking – I”m not a tax guy, just guessing at the way these numbers look.
Sure, if their /taxable/ income stays the same they might pay less, but the whole effort to systematically eliminate deductions that lots of working people were taking (recall, they were also talking about eliminating mortgage interest, 401k contributions, etc) were intentional in their goal to increase /taxable/ income.
In short, itemizing is now a complete joke, unless you’re super-rich /and/ giving lots of money to some form of charity (of note is the extensive use of fake foundations and charities by the very rich to shield income anyway), and then maybe living in a house with property taxes ~$10,000. What this means is that regular people who /were/ given tax breaks on things do not anymore..
Now, I’m not saying that those tax breaks were good or bad, I’m just saying that this is how the numbers work. And this is what people are getting at when they’re saying that taxes are going “up”. You’re not wrong – you’re just wrong in assuming that taxable income remains somewhat steady – which I’m not so sure it does. Of course, I could be wrong on this point..
Correct me if I’m wrong on these assumptions..
As usual the Fed closes the barn door long after the cow is gone.
Visions of 1937, when tightening too early caused the economy to suffer a second crash, after the major 1929 event. Extending the depression.
This economy is dependent on credit. The bigger the the accumulated debt is when compared to GDP, the more likely it is that a reduction in credit will cause an economic crisis. Hiking rates reduces credit.
Most consumers no longer have any discretionary income with which to consume with. They now rely solely upon credit to maintain their life styles. The Fed has well and truly backed itself into a corner, from which there is no escape without causing much economic pain.
I’d say it was quite the opposite. The tightening should have happened in 2013, but since the FED uses a bogus inflation metric, they could justify letting things ride. Personally, it seems very politically motivated though. Its amazing that nearly every rate hike happened after the election, as to not upset the markets for a certain someone who was thought was going to be President. It wouldnt suprise me if the markets were forced into a correction before November 2020.
Completely agree – tightening should have started in 2013. Inflation was kicking in – i could distinctly feel it in every shop and restaurant and open house.
“The Fed has well and truly backed itself into a corner, from which there is no escape without causing much economic pain.”
Since the general population will be the victims regardless of what the Fed does, the Fed is free to act in the interests of its hyperrich constituency.
Despite its bleatings to the contrary, the Fed can be expected to maintain a loose monetary policy, because that’s what’s keeping the stock markets up. Equities are certainly not supported by the real economy, because that has not recovered. Skyrocketing stock prices are no reflection of the dismal performance of the underlying economy.
Fed policy has been very successfully designed to enrich the wealthy while keeping the real economy down and the general population servile. Helping the real economy, and therefore the general population, would be contrary to the goal of bleeding the country.
The inflated paper wealth is just the same asset at ever higher prices.
This bubble economy just keeps squeezing the middle class with more debt and less wages.
Eventually this de facto default that is implied, when the government must print in order to support the market and make the interest and principal payments on its ever increasing debt due to higher rates, will cause a price discovery event to occur that crashes the value of all bond funds.
The corporate state will do what all despotic regimes do – govern through wholesale surveillance, lies, blacklists, false accusations of treason, heavy handed censorship and eventually violence.
Any fully awake and conscious person, can see that we are well on this present road to perdition at present.
One of two things is going to happen, the stock market will crash and rates will come down, or the economy will collapse, sub 2% inflation, and the rate hike program will end dramatically.
I just remember the interest rate change on my very first mortgage in 1981. It rose from 8% to 18.5% upon expiration of the 5 year term. Obviously, the resulting recession was a nightmare for many and it took me a decade to regroup. I had two little kids and my wife stayed at home to look after them. I had to work away for three month stretches, and when I switched to local employment we barely got by. My wife eventually went back to work when our youngest child hit grade one, and life has never been the same for most married couples since, with almost all of my adult children’s cohort holding down jobs, paying off student loans, and scrambling to get by; plus paying for childcare for only a slight net-gain.
Never say never. In 1981 the ‘good times rollin’ crashed in less than one year and the hindsight warning signs were never mentioned by anyone I ever knew. I remember adults, who had lived through the Great Depression, saying they believed interest rates would never drop below 12%. :-)
Credit has to dry up to manipulate and wrestle down inflation. There is supposedly low inflation now, but it will happen. And when will that be? When wage increases/demands start to bite the .1% entitlements I suppose, LOL.
And now here we are. I went to the store the other day and BC grown apples were just under $2.00 per pound. I bought some spartans for $1.47. Mushy field apples were $.97 per pound and you could stick a finger through them they were so mealy.
I’m retired now, but if I was still working and trying to raise a family I would be extremely frustrated and committed to job shopping for an improvement.
The other point I wish to make is back then, we were like deer in the headlights. I think people are more volatile now. I really sense a cynicism we didn’t have. We just worked harder and over time things improved. Many young people now are already working harder and not getting by. They won’t go down, quietly…imho.
This will no doubt be followed by the usual naysayers who think the lowest real rates in at least a 100 years are here forever. (One UK bank economist has said real interest rates are the lowest in 5000 years.)
Much of the world is in this state. They resemble the frog who will jump out of hot water but won’t jump out of gradually heated water and perishes. For their own good, maybe it’s time for a .5 bump in the Fed rate.
If I remember correctly, the Bank of England historically set the rates for the rest of the world, and it was usually at least 3%. The rate was published in newspapers going back to colonial times.
True. And England went through over a century with zero inflation.
The 3 % was a real interest rate. If inflation is 2 % , to have a real interest rate of 3%, the nominal rate would have to be 5%.
BTW: it’s not necessary to go back that far to find near zero inflation.
A bottle of coke in the US was 10 cents for half a century.
The American Pickers are always buying vending machines from the 40’s and maybe even the 50’s where the price of 5 cents is actually cast into the metal.
Inflation really took off after the Arab-Israeli war of 73-74 when the price of oil began its climb from a dollar a barrel to a hundred a barrel.
Ah no, it was not the Arab-Israeli war that produced inflation, it was the Vietnam War and Johnson’s complete unwillingness to raise taxes to support that war. He spoke of the “Great Society”. His mantra was “Guns AND Butter”. Nixon certainly didn’t make things any better, but he inherited a God-awful mess.
Both are factors but the increase in the price of oil ended up at two orders of magnitude or 10,000 percent.
There were indirect effects of the US domestic situation abroad but they were relatively gradual unlike the aptly named ‘oil shock’.
Apart from energy, oil is the feed stock for plastics etc. and affected every country, even those where balanced budgets were religion and inflation was a sin.
True, Nixon took the US off the gold standard as a result of Vietnam spending but this took a while to move even the price of gold. The oil shock was instant.
The war in Vietnam did wind down eventually but oil although volatile remained much more expensive and permanently increased the cost of operating a developed economy.
The two factors are related in that the Gulf States wanted more US $ per barrel as the dollar weakened due to decoupling from gold. But it was only when they decided to use the ‘oil weapon’ in 1974 that they discovered how far they could push the price.
Seven years later the Feds had to save Chrysler from bankruptcy.
Reminds me of the pre-crisis time, when the air has already left the balloon. The economists’ opinion was that rates would have to be cut to, horror, 3% to arrest the decline.
Up until then, the economists, including the Nobelistas could claim to be a decent profession..so maybe there is one upside to this state of affairs.
“This will no doubt be followed by the usual naysayers who think the lowest real rates in at least a 100 years are here forever.”
As long as the world is stuck in a quagmire of disinflation/deflation and attempts to grow its way out of… extremely indebted positions with more debt… yeah, low rates are here for a while.
Increasing deficits, which aren’t going away, will lead to short-term transitory growth spurts, but less and less growth in the long run, and lower and lower rates. There’s only ever been two ways out of this: painful austerity (which can be multi-decade), or economic miracles. Some examples of economic miracles would be the gold rush of the 1850s (infrastructure overexpansion, e.g. canal and railroad systems), and WW2 (Great Depression).
“One UK bank economist has said real interest rates are the lowest in 5000 years.”
There’s that pesky “demographics” thing. Economic growth = population growth + growth in capital stock. It’s not a coincidence that low rates are the lowest in 5000 years while the global birth rate is the lowest in record history. It’s almost halved since 1970. Virtually all of the developed world is close to, or below replacement level, as well as parts of the developing world (e.g. China, Russia, Brazil). The only part of the world pumping out babies right now is sub-Saharan Africa.
I personally don’t see any changes in birth rates on the horizon (except to continue declining), and even if we did have an “economic miracle” I suspect the way our country, and much of the world, is set up right now… it would predominantly accrue to the people who need it the least, and not actually substantively solve our problems like it might have in the past.
As to the population issue, the economy doesn’t need an ever increasing number of uneducated peasants or laborers to do work anymore. Technology is making jobs of the high school educated and below obsolete, and it will make jobs of the college educated and below outside of a few specialized fields obsolete very soon too. For starters, anyone operating machinery, a vehicle, or doing any other repeatable, rote task for a living ought to be thinking about a career plan B ASAP…
Future jobs will likely only need to exist for most cognitively skilled of the population (maybe 10-20%). Everything else is going to be automated or otherwise made redundant. We will need far fewer humans around in the world for the same economic output, and really only the smartest ones with the highest level skill sets at that. This technological advancement, along with the staggering concentration of wealth in the hands of a few who can’t spend it fast enough, gives you the current disinflation.
Maybe then we’ll learn how to use the 3 seashells.
Honestly, that movie is the best prediction, I think, of what’s coming. A tiny elite and hordes of ragged, barely-surviving raiders.
We’re progressing right in that direction. Look at countries in Africa with a tiny ruling class that live like upper-middle-class Americans and then the rest of the population lives in shantytowns. That’s what we’re headed for.
The litmus test for the Fed will be what happens when the market appreciably sells off. An August ’15 or January ’16 repeat.
They’re worried about asset bubbles via loose financial conditions– but then they’re worried about a crash in the same asset bubbles presumably brought about by tightening financial conditions.
So it sounds like they would have liked to tighten before these asset bubbles blew everywhere– but couldn’t due to low inflation and growth. And now what we’re stuck with is asset bubbles everywhere– and still low growth.
In other words, they’ve quite effectively proven that continued and extended monetary stimulus does little to help the real economy, but it seems to me they don’t want the experiment to be labeled a failure. And it’s becoming increasingly apparent the only way to do that is with continued and extended monetary stimulus.
Quite the quandary they’ve got themselves in!
“The Fed Might “Surprise” Markets with its Hawkishness in 2018”
But if the Fed says natural rate is 2.75 and it’s 1.50 now and they raise it to 2.25 end of 2018 with 3 teenie tinnie 0.25 rate hikes , that’s still non-hawkish and asset value expansionary. It takes the Fed into an additional year of unprecedented dovish asset inflation.
How is that hawkish? Why doesn’t the Fed do a 1.00 hike in December? or a 1.50 hike? or a 2.00 hike which would put the Fed into a slightly hawkish position?
They seem to wish to avoid a crash by inducing a contraction. They need asset prices to stop soaring so that they can rein in the banks from lending on inflated asset values. The problem is that most of us see this machine as capable of either ratcheting up values or destroying them–some kind of happy equilibrium is simply not how the real world works. The central banks want the sun to stand still in the sky. That’s not how capitalism operates. It grows or it shrinks. That’s why it is, in the end, incompatible with the natural world. It demands infinite growth in a finite system that can only take so much strip mining and so many negative externalities.
Wolf, I remember very well your article in January of this year in which you spelled out the interest on excess reserves (IOER) that taxpayers paid to banks in 2016.
I have noticed that during 2017 the Fed has continued to raise the interest rate it pays on excess reserves in lockstep with the overnight rate:
1. Do you think that there will ever be a divergence between those two rates and, if so, how will they diverge, or will those two interest rates remain identical for another year?
2. How expensive will the Christmas gift — the gift that keeps on taking — be that US taxpayers are going to be forced to put under the banks’ Christmas tree this year?
Concerning #1: So far it has raised both rates in lockstep. The rate on excess reserves is currently 1.25%. But also, those excess reserves have dropped by $600 billion since the peak in Aug 2014 and are now at $2.1 trillion. So the total amount of money paid out might not surge in parallel with the rate hikes.
Concerning #2: Every year, the Fed remits to the US Treasury (the taxpayer) most of its profits. For 2016, it remitted about $92 billion. It’s via these remittances that the taxpayer will feel the interest payments made to the banks.
It works like this: The Fed gets the interest payments from the securities it holds (Treasuries and MBS). It uses part of this money to pay for its own operating expenses. The interest that the Fed pays the banks on their excess reserves is also paid out of this revenue stream. So what happens is that the amount of the remittances drops, as it did last year, and as it will drop more significantly for 2017. Here is a chart of those remittances through 2016 (in billion $):
So in January 2018, when the Fed publishes the estimated remittances for 2017, there will be a lot of talk about the Fed’s “profit” and how it helps the taxpayer. But my guess is that the profit will be below $80 billion and that the Fed paid the banks about $20 billion in interest in 2017.
Not much will be said about who got the $20 billion that the taxpayer didn’t get – though I might write about it :-]
Where did the excess reserves go? Didn’t the FED had to soak them up to effectively raise the target rate? Couldn’t that explain why they are in lockstep?
The Fed so far has raised the target range for the fed funds rate and the rate for the excess reserves in lockstep, as part of its announcements. But it doesn’t have to do this. It can raise one and lower the other, for example. It also could have left the rate on excess reserves at zero.
The mainstream Analysis Seems focused on interest rates, it SEEMS to have already forgotten the Balance sheet reduction program.
Which has the potential to tighten money supply and drive up the $, as foreign QE Cash (Mostly from Europe and china). Continues to pour into the space created by FED balance sheet reduction.
It will be interesting to see how this reduction does or dosent progress in 2018.
If the reduction continues as projected the FED will have additional Tested tools at its disposal, no matter which way the Economy moves.
ZIRP policy’s have been shown to benefit the wrong groups of an economy in Recession/Correction, unless you wish to make the rich, richer.
Just as QE has been show to be only very short term effective on an economy in Recession/Correction with out:
1 Synchronised regional if not global CB Action.
And much more importantly.
2 Administration Policy’s Geared and synchronised with QE to stimulate activity (And so Employment) at the bottom of the economy NOT the top.
Monetary policy alone can not resolve negative Economic issues, in a Recession/Correction.
Nobody has much good to say about the FEd it is a soft and easy target.
What the fed will have done is learnt from these last 25 years. Just as it is now learning how top get out of bloated QE Balance sheet possibly without causing serious financial mayhem.
The FED has recapitalised the US bank’s (at the expense of saver’s).
What the FED needs now, is a replacement of the replacement of the principles of Glass Steagal in law and possibly some tools to regulate the interest rates charged by all lending institutions/Entities.
What it is faced with is an administration wedded to crony Laissez-faire capitalism, only interested in feathering its own nest.
Pushing Interest rates much beyond 2.5 – 3.5 % would have a negative effect on the Administration budget. The fed has plenty of other Tools, before it needs to look at that option.
What the FED does not have is an administration that will aid it in other ways, that would, as a side effect, reduce some corporate profits, but help to GENTLY reduce the asset bubbles.
So 2018 could be interesting.
The Fed is trying to normalize.
The Fed is succeeding at getting solid inflation after a number of years of low inflatiion. The money was printed and now we have enough “velocity” to work it into the system.
BUT…..the economy is bifarcated. Some get pay raises for inflation. Most don’t. So for most, inflation is really stagflation.
Low interest rates have juiced a number of industries (autos, housing, corporate buy-backs). BUT…low interest has hurt a number of industries (insurance, Mr and Mrs. retired saver).
The solution to America’s economic problems cannot be solved by the Fed. They are structural, not monetary.
The Fed will continue to normalize interest but they will create a recession in the process. Don’t worry about the stock market. It is being manipulated higher for now by the Wall Street banks that do the Fed’s bidding. This is all theatre to make it look like normalization is doing just fine. But at some point in the next year, the slow up will be unmistakable. Then it will get interesting.
I have absolutely no doubt the Fed will have to do more QE in the coming years.
“The Fed will continue to normalize interest but they will create a recession in the process.”
They may appear to, If the administration does not cooperate with them.
Then as usual everybody will blame the FED. As its a soft, and easy, Target.
Japan, is all I need say. How about almost all of Europe in negative rate territory?
PhD economists taking away the punch bowl? I really want someone to explain how the FED board will suffer if they blow up the world again? Most people in the real world have to provide results to justify their positions.
Rates will ONLY rise when the dollars worth is questioned, not before.
“Most people in the real world have to provide results to justify their positions. ”
And the FED clearly does, specifically in the interest of their actual employers. That’s how we got to where we are today.
What people seem to forget is that rate hikes is a way to pay for tax cuts. And that current FED rates are still amazingly low.
The rate hikes brake the whole economy. The tax reform shifts money upward, especially after the first few years and especially for the very wealthy.
The merely well off will see varied results. Seems it is better to be in a red state for those people. Interesting aspect to the reform. Accidental?
Rates on excess reserves are highest now as ever in history, aren’t they?
Hopefully it’s just me being dumb and the reality is people around me are much smarter than me.
I’d like to see more of a return on my savings. These last few years, I’ve been putting new money into savings versus equities, since the stock market has been reported, for a long time, as over valued.
Higher interest rates would also help pension funds.
Your first paragraph said it all with “the target for the federal funds rate.” It is the target that is rising, not necessarily the rate itself. I know of one instance several years ago when the target was raised from 0.10 by 0.25. The average for the actual rates for a period of time after that was 0.12. So: 0.10+0.25=0.12? I think not. That was an eyeopener. If that’s still going on, perhaps that’s why the tightening didn’t work. The tightening was in the jawboning, not the actuality.
Thanks for your precisions. Your articles are always worth reading because of them.
How the target translates into market rates shows up in the 1-month and 3-month yields, and they do not always follow the Fed’s moves. For example, when the debt ceiling deadline moved closer, and Congress couldn’t agree on anything, short-term yields suddenly surged for a few days before settling back down. This had nothing to do with the Fed, but with the fear that the Treasury might not have enough money to redeem the securities that would mature in that time frame.
Yesterday the 3-month yield closed at 1.29%. So in sync with the Fed.
The rates I was referring to were what the Fed was lending to banks at the time. I don’t know what the Treasuries were doing at the time. The point I was trying to make was that the Target rates and the Actual rates may not be the same thing.
Well, supposedly we have full employment (which I cannot believe is true) so rates should increase.
Perhaps what the FED really intends to do is increase the rate on excess reserves for their banker buddies so they can afford to refill the fuel tanks of their Rolls-Royces and continue on, completely ignoring the flattening yield curve.
“the Fed…has since done everything it said it would do, including the QE unwind that commenced in October.”
A quick update on progress so far would be helpful…???
Thursday afternoon, the Fed’s new balance sheet will come out. It will include Nov 30 when a bunch of Treasuries matured that were on the Fed’s books. We need to see what the Fed did with them. Also MBS are going to be interesting. I will have an article on this later on Thursday to cover the month of November.
Spoiler alert: there will be no surprises in 2018 or any other year. The Fed will do what it’s done since 1913: craft its monetary policies to turn billionaires into trillionaires.