Tag Archives: Inflation

Seeing the Positives from the European Debacle

What happened in the stock market two weeks ago was scary: the Dow dropped 1,000 points in a matter of minutes.  Greece was on the brink of defaulting on it’s debt; a country I might add, that has it’s currency denominated in Euros.   Investors were worried that if Greece went down, it might drag down the Euro with it.  Luckily, the EU finally pushed politics aside and realized that in order to keep the EU from causing a European Lehman chain reaction, they had to bail out Greece.  If Greece went, so the saying goes, the rest of Portugal, Italy and Spain would go with it.  As the bail out was announced, U.S. stocks surged.  But the damage was done.

Stocks are still up since a year ago, but a lot of that equity was lost.  Some say it was a much needed market correction.  In a way, I agree.  Investors started to feel that they were being left out of the party (considering that stocks rallied considerably since March 2009) and wanted to get into the action, driving up valuations.    The market correction has left some worried that the lost momentum from the stock market and the teetering European situation means that the U.S. is going to lose steam in it’s recovery.  But it won’t; it will only make our recovery stronger.  There are several positive indications that Europe’s struggle is in America’s benefit.

  1. A stronger dollar against the Euro should help bring in an influx of investment.  While a weaker dollar sent investors over seas, most wealth generated outside of the U.S. will start seeking to invest here.*
  2. The Fed funds rate is still around 0% to .25%.  Inflation hawks are going to have to start rethinking their position as deflationary pressures continue to rear its ugly head.  Mean trimmed CPI is on a downward trend, and with energy and commodity prices pointing lower, it will only continue to send overall prices downward.   This type of environment will keep the Fed from raising rates, making borrowing cheap.  With mortgage rates continuing to be low, buying a house is still attractive.
  3. The potential benefit for having low interest rates is that foreign investors looking for returns will look towards equity markets.  This means more potential growth for U.S. companies and the stock market.
  4. The stock market wasn’t the only thing that experienced slides.  So did commodity prices, especially oil.  Oil was moving up to around $90 a barrel until the market correction happened.  Now, oil prices are down to $75 a barrel.   Any increase in gas prices is taxing on consumers, but so far, gas prices have stagnated and won’t be increasing any longer.  The cost of inputs are now lower across the board thanks to declines in commodity prices, providing cushy margins for companies that lowers the pressure to raise prices, resulting in an absence of pain for the consumer.

As you can see, there is upside to the European situation.  I agree that it is still a gloomy situation for Europe in general.  Greece (and the like) face long-term structural issues that will make resolving their situation an incredibly hard task and I won’t be surprised if in 6 months Greece begins to default on its debt again.  But will it really drag down the EU? The rest of the countries such as Portugal, Spain and Italy should benefit from a lower Euro, helping wages that outpace productivity come to parity.  So should Germany and the rest of Europe, as a lower Euro will stimulate exports.  What needed to happen was a devaluation of the Euro  to a value more inline of what it is worth.  Yes, it is unfortunate that these irresponsible countries are essentially a drag on the EU, but that doesn’t mean the U.S. will have to suffer for it.

While the EU is a major trading partner to the U.S., I doubt there will be significant drops in demand for U.S. goods. There are more, higher growth areas for the U.S. to consider.  In terms of the U.S. recovery, if exports were the upside to the U.S. downturn, then U.S. exports to Europe is going to be the downside to the U.S. recovery.  But there is going to be a recovery nonetheless.

*And in minutes, this pops into my RSS reader: China boosts holdings of US Treasury debt by 2 pct

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Inflation? What Inflation?

From Free Exchange

A Case for the Investment Tax Credit

Obama has recently sparked debate about a proposal to spark job creation.  He wants the proposal to include incentives for small businesses to hire more workers, spend more money for infrastructure projects and offer rebates for homeowners who update their homes with energy efficient durable goods and weatherization renovations — that has come to be known as “cash for caulkers.”  The debate around the blog world has included some interesting ideas, including the “cash for caulkers” idea itself and a cut in the minimum wage, which has spurred tremendous uproar in the blogging community for and against it.

One proposal that has caught my eye is the Investment Tax Credit. (ITC) Mankiw has made several good points about the ITC that is well worth looking at.  First, a temporary ITC could help act as a similar mechanism to create negative real interest rates, much like what inflation could do, even though quantitative easing is now out of the question given Bernanke’s recent remarks. Second, like cash-for-clunkers, it would help stimulate AD in the short-run and move AS rightward in the long-run, but broadly so as to not favor a specific industry. And lastly, tax credits usually are a good idea if you want more of something.  Considering how low investment growth is, it would only make sense to target tax credits on something like investment.  If businesses focus on investing, it will help stimulate demand for capital goods, increasing the need for more labor to supply it.

If opponents want to say that this may just stimulate demand for investment in foreign capital goods, I would say that most investment worthy capital goods would be created here in the U.S.  Less value added products that usually come from abroad, if do happen to be purchased, still doesn’t mean that the products wouldn’t go toward future productivity and lower unit costs.  For what its worth, the economics out rightly support the ITC.

To drive the point further, Obama should really listen to what small businesses actually want.  Yes, America wants jobs, but small businesses are not going to hire unless they get what they want first.  While the blogosphere argues over lowering labor costs with the minimum wage, small businesses are asking for something different.   From Peter Crabb:

The latest reading of the National Federation of Independent Business (NFIB) Index of Small Business Optimism was down, but business owners don’t see a lack of bank loans as a problem.Twenty-nine percent of all respondents to the NFIB survey reported they have met their borrowing needs. Nine percent reported problems obtaining financing, which is one point lower than the previous period.

Why are small businesses not desperately seeking more financing? Because they have little reason to invest in their companies. In the survey, only 16 percent said they are making capital-expenditure plans for the next few months. Only 8 percent said the current period is a good time to expand facilities, and only 3 percent think the economy will improve.

Small businesses are not concerned about getting loans for making investment into their companies. In fact, among their chief concerns are:

[From the NFIB report] …we find that when asked to identify the most important problem small-business owners face at this time, poor sales are cited most frequently, high taxes second and government requirements third.

It seems that their chief concern is with demand. Small-businesses don’t necessarily care about making investments right now as they need revenues to catch up first. However, whether or not small business are enticed by an ITC, larger businesses would be. I am sure many companies would be willing to take advantage of it. And the downside? No one takes advantage of it and the treasury account stays the same.

Some more cases for the ITC can be found here and here.

Commodity Price Inflation

Econbrowser has an interesting analysis on the recent, average commodity appreciation of 34%. This graph, which is from a recent paper by Ke Tang and Wei Xiong, has certainly resonated with me:

Why the correlation between certain commodity prices and oil? It is important to note that the correlation uses a rolling sample beginning one year before indicated date of returns on oil versus commodities. Unlike popular belief that currency devaluation is driving the recent commodity boom, rising oil prices is the major driver for commodity inflation.

The paper also believes that commodity inflation have been caused by commodities becoming a popular investment vehicle. However, I believe that is simply a consequence of rising world demand. If the former is true, then we would have another bubble in store. If the latter is believed, then we would expect worldwide inflation. Depending which comes first, both may be in the same feedback loop, so unfortunately, both would create a vicious cycle where as one increases, the other follows.

One would think that an increase in rates would immediately fix this.  But, that may be premature.  If oil is the big driver, then what is really needed is substitution away from oil.  Could lithium become the next commodity to drive commodity price inflation after a huge electric car boom takes charge during another oil shock? What other alternatives are there? Tax fuel for all non-commercial vehicles (electric or not)?