Federal Reserve and Monetary Policy: Chavez's Curve Ball

Venezuela's pres. Chavez has made good of his promise regarding giving heating oil for the poor. Call it what you want, but the reality of the situation can not be denied. The United States of America has a very big rift. This rift is so big as to allow a populist, Chavez, to gain political allies. Wall Street is going to come back from its holiday and contend with the possibility that, at the minimum, Bush has to answer this challenge and become side track to the point were his agenda is now dead and buried. The other end of the spectrum is the possibility of class warfare. One should expect social unrest when it becomes a government policy (one can include Wall Street) of placing more value on land rather than on its people (serfdom and feudal lords).

Russia's Proletariat vs Bourgeois is the closest historical event. An unpopular war (WWI) and an unpopular leader (the Czar). Mix in some economic hardships for the serfs and a social elites/aristocrats and poof, a revolt.

Oil or to be more precisely the value of Oil is not the main cause. I do admit that it is a factor, but it is not that which causes economic instability. I will explain by making the following observation (without proof): “Economic system under a Monarch/dictatorships and economic system under a “pure” capitalist sociality are duals to each other”. In the long run, these economic systems prevent upward mobility and are, therefore, unstable.

The closest economic system of the current global economy is a mercantile system. A handy source is Adam Smith's An Inquiry into the Nature and Causes of the Wealth of Nations
Excerpt from “Of the Principle of the Commercial or Mercantile System”;
“Others admit that if a nation could be separated from all the world, it would be of no consequence how much, or how little money circulated in it. The consumable goods which were circulated by means of this money would only be exchanged for a greater or a smaller number of pieces; but the real wealth or poverty of the country, they allow, would depend altogether upon the abundance or scarcity of those consumable goods. But it is otherwise, they think, with countries which have connections with foreign nations, and which are obliged to carry on foreign wars, and to maintain fleets and armies in distant countries. This, they say, cannot be done but by sending abroad money to pay them with; and a nation cannot send much money abroad unless it has a good deal at home. Every such nation, therefore, must endeavour in time of peace to accumulate gold and silver that, when occasion requires, it may have wherewithal to carry on foreign wars. “
...
“They represented, secondly, that this prohibition could not hinder the exportation of gold and silver, which, on account of the smallness of their bulk in proportion to their value, could easily be smuggled abroad.*9 That this exportation could only be prevented by a proper attention to, what they called, the balance of trade.*10 That when the country exported to a greater value than it imported, a balance became due to it from foreign nations, which was necessarily paid to it in gold and silver, and thereby increased the quantity of those metals in the kingdom. But that when it imported to a greater value than it exported, a contrary balance became due to foreign nations, which was necessarily paid to them in the same manner, and thereby diminished that quantity. That in this case to prohibit the exportation of those metals could not prevent it, but only, by making it more dangerous, render it more expensive. That the exchange was thereby turned more against the country which owed the balance than it otherwise might have been; the merchant who purchased a bill upon the foreign country being obliged to pay the banker who sold it, not only for the natural risk, trouble, and expence of sending the money thither, but for the extraordinary risk arising from the prohibition. But that the more the exchange was against any country, the more the balance of trade became necessarily against it; the money of that country becoming necessarily of so much less value in comparison with that of the country to which the balance was due. That if the exchange between England and Holland, for example, was five per cent. against England, it would require a hundred and five ounces of silver in England to purchase a bill for a hundred ounces of silver in Holland: that a hundred and five ounces of silver in England, therefore, would be worth only a hundred ounces of silver in Holland, and would purchase only a proportionable quantity of Dutch goods; but that a hundred ounces of silver in Holland, on the contrary, would be worth a hundred and five ounces in England, and would purchase a proportionable quantity of English goods: that the English goods which were sold to Holland would be sold so much cheaper; and the Dutch goods which were sold to England so much dearer by the difference of the exchange; that the one would draw so much less Dutch money to England, and the other so much more English money to Holland, as this difference amounted to: and that the balance of trade, therefore, would necessarily be so much more against England, and would require a greater balance of gold and silver to be exported to Holland.”
One can substitute gold and silver for oil if one wants, however, I tend to think that it is more appropriate to use the “value of Land”. This implies that the pieces of wealth that are exchanged are in fact mortgages. According Smith, as long as the US's wealth is in its land then one can have a current account deficit (using modern terminology).
“No foreign war of great expence or duration could conveniently be carried on by the exportation of the rude produce of the soil. The expence of sending such a quantity of it to a foreign country as might purchase the pay and provisions of an army would be too great. Few countries produce much more rude produce than what is sufficient for the subsistence of their own inhabitants. To send abroad any great quantity of it, therefore, would be to send abroad a part of the necessary subsistence of the people. It is otherwise with the exportation of manufactures. The maintenance of the people employed in them is kept at home, and only the surplus part of their work is exported...”

Mortgages or more specifically mortgage-related securities held by foreign investors work. I personally connected/substituted the “value of Land” to that of Money/gold/sliver in order to make the following points:

• Chavez is taking advantage of the split in the US. A very good curve ball.


• Upward mobility has become stagnant:

“The exclusive privileges of corporations, statutes of apprenticeship,*78 and all those laws which restrain, in particular employments, the competition to a smaller number than might otherwise go into them, have the same tendency, though in a less degree. They are a sort of enlarged monopolies, and may frequently, for ages together, and in whole classes of employments, keep up the market price of particular commodities above the natural price, and maintain both the wages of the labour and the profits of the stock employed about them somewhat above their natural rate.“

The exclusivity of trade guilds (Monarchs) and the free wheel dealings of a capitalist society (monopolies) have the effect of stopping technological changes necessary to evolve a society. It is the lack of upward mobility that has allowed Chavez to pitch his curve ball. It is up to our so called elected officials to respond and prevent Chavez from pitching a shutout game.

“Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies, and amusements of human life.*1 But after the division of labour has once thoroughly taken place, it is but a very small part of these with which a man's own labour can supply him. The far greater part of them he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities”

(A weak proof for the duality between Monarchs and a “pure” capitalistic society)

Land that is not used for production is land that does not need labors. The housing boom has, in effect, reduced the value of labor. Since labor determines the exchange value of all commodities, this reduction in labor usage has reduced the “Value of the Land”. In order to make up that value, with respect to the current account deficit, one must be a large land owner. In general, there is an “Aggregate Land Monopoly” (home owners). One can take the position that one should by a house. This is the problem. Home owners do not want to see their housing value go down. The housing affordability index limits new home buyers. If you are not a land owner then you are a labor. If you are a labor, your value has been decreased. This is true even for the most educated US citizen.

I admit that this is the extreme case. However, the CBO has released a report: The Role of Immigrantsin the U.S. Labor Market They did a nice job of not saying the obvious: Wages are in decline. I really don't care as to the reason wages are in decline, just the fact that they are. The outcome of the wage decline is apparent. Airlines can not meet their cost and auto makers can not charge the price they want.

One must take into account the diverges between housing prices and the affordability index. This can be explained by recognizing the fact that there is a supply and demand for mortgage-related securities. An example of this relationship is the following: Charles Swab offered Home Equity Line of Credit to homeowners whose houses were destroyed by Katrina. This action is irrational by a financial institution. They made the assumption that the value of the land would not decrease. This has place extraordinary on the insurance sector. There is an argument between homeowners and insurance companies as to “water damage” This argument is a sticking point and will place the US government in the position to rebuild the land in order to maintain its value.

There is a emotional desire to keep ones property even in the face of “having to reduce ones labor value” as long as financial institutions are willing to supply credit. I think Adam Smith would be appalled by the fact that so much wealth is being given to land that has no production (output).

In a very general way, one can almost make up the difference of the trade deficit by adding in securities. See F.210 Agency and GSE-backed Securities and Flow of Funds Matrix.

The global market will protect its investments through the process of greed and fear. The reaction of having the US government spending $60 billion on hurricane relief can be indicated by the dollar index. There was more of a knee-jerk reaction to the interruption of the latest fed minutes as toward a pause in rate hikes than there was to the spending of $60 billion and the possible cost of $200 billion.

Federal Reserve and Monetary Policy: Global Inflation Target

Morgan Stanley chief economist Stephen Roach is right in his view that Bernanke is going to have a problem with housing, however, he has missed his own solution. The basic problem with globalism is one of GDP equalization. It has been my opinion that there is a link between the trade deficit on government debt. Part of that link is the lack of income/tax revenue due to exporting raw materials to the US's factory floor in China and the increased in energy usage because India has become the back office for the US (the cost of the income/tax revenue gap is, to the first order, the trade deficit). India is not an economic crises. China is an economic crises.
The problem is Wall Street, which is the source Roach needs to acknowledge. He also has to acknowledge the problem also lies with Washington DC. One must recognize the fact that the US is playing the globalism game one way and other countries are playing the game another. The “Beltway” has to come to grips with the fact that the EU may shatter, Russia will not reduced its oil tax and China is pushing its sphere of influence into the oil rich Middle East (Iran and a sea port in Syria).

Only in America do the oil companies and other natural resource companies, own that resource. Countries like Russia own the oil and the oil company just acts as a “distribution” for that resource. The “Beltway” has to recognize that it is unlikely the “Globalism” will change this. Once the “Beltway” recognizes the nonequivalents of the application of “Globalism” rules then the solution to a housing bubble crises becomes apparent: remove Wall Street from the distribution of US tax dollars. In other words remove the repatriation of over seas profits (GE's TAX bill) and other tax breaks that has the same effect (tax breaks on mortgages interest payed, etc...). Not all tax breaks are equal. Take those taxes and push it into the local economy. Give multi-nations a tax break on overseas profits if and only if they reinvest it into creating US jobs. They do not get these tax breaks if they use it for stock buy backs and dividends. This will have the following effect; the US “Land Bank” retains its value because people can continue to pay their debts if these profits are plowed directly into the local economy of the US. If the multi-nations choose to keep their overseas profits overseas, then there is a probability that it will be invested in some of the cheap labor markets. This in turn will help these developing nations' GDP and hence accelerate the equalization of global GDP. If one looks at Scalar Multiplication of a Convolution in The Intensive Production Function and the Producer's matrix of Transition Probabilities section of my Neoclassical Theory of Production blog then one can gain an understanding how this is possible.

I know there are some who will differer on this, but Wall Street has become part of the global market. It is no longer the “center” of the universe. US multi-nationals created a monster when they decided it was ok to off-shore their back offices and move their manufacturing floor to China. They can no longer control their creation (you know the story of Frankenstein's Monster). Wall Street is in the way of globalization. Companies has merged, taken over, increased dividends and bought back stock, yet the equity market has not gained. This is their child's way of saying that they what their cash hoard to be invested to maintain global economic growth.

The only thing the Federal Reserve has to do is to try to make US interest rates competitive with respect to the rest of the globe. It is unlikely that they can make the flow of investments reverse from China and back into the US. In other words, the dollar will signal a neutral stance and the global financial markets will not place the dollar into crises because of a housing bubble popping. The global market has sent a clear signal due to the information of increased government spending after Katrina. Not all government spending is “evil”.

China is a black hole for investments and it is impossible to change this unless China changes its command economy. I know this and through the process of “greed and fear” the global market will come to the same strategy. If there is a current account deficit melt down it will be due to the current tax policy.

I believe that there is a GDP equalization in progress. It therefore makes Bernanke's theory to have a target for inflation, but this target is for the global markets. (Inflation Target => Increase in Global GDP).

Federal Reserve and Monetary Policy: Bernanke and the $Dollar

I was watching CNBC’s coverage of Bernanke’s nomination for the position of Chairman of the Federal Reserver. Normally a nomination would not prompt me to write, however, former Federal Reserve Governor Brimmer made a statement that caught my attention. He said that Bernanke should consider global markets only at the margins (I’m paraphrasing). I believe that this attuide and/or actions will only box in the Federal Reserve when it comes to making monetary policy. Read my blogs: Federal Reserve and Monetary Policy and Neoclassical Theory of Production. Consider the following:
I’ve stated, my opinion, that the trade deficit and government debt are linked and are, in fact, ‘Twin Deficits’. I’m including local, state and federal debts. See the following for Bernanke’s views: March 10, 2005 The Global Saving Glut and the U.S. Current Account Deficit.
“Here I simply note that the so-called twin-deficits hypothesis, that government budget deficits cause current account deficits, does not account for the fact that the U.S. external deficit expanded by about $300 billion between 1996 and 2000, a period during which the federal budget was in surplus and projected to remain so. Nor, for that matter, does the twin-deficits hypothesis shed any light on why a number of major countries, including Germany and Japan, continue to run large current account surpluses despite government budget deficits that are similar in size (as a share of GDP) to that of the United States. It seems unlikely, therefore, that changes in the U.S. government budget position can entirely explain the behavior of the U.S. current account over the past decade.” The world has changed.
Keynes has concluded that GDP is made up with public, private and government investments. A Chinese businssmann has stated that Bush’s tax policy is a boom for him. This implies Bush’s tax policy has a very big “leak”.
India is not an economic crisis. The country has made great strides to allow both currency and information to flow freely. I know that there is inflation and inflationary expectations due to increases in wage and salaries. This is important to me because I’m in the process of starting a web service company. China is a different story. They have a Communist government and a command economy. This means that neither information nor currency can flow freely. China is an economic crisis. There is an economic accident, Greenspan’s words (see: Energy) , out there and it will involve China.
Now the connection: I’ve stated that off-shoring expands the community. Using a global, progressive tax system implies that the expanded communities’ output is not being credited to the US of A communities’ output. I’ll make a simple connection. Off-shoring has made US of A’s natural resources less valuable. During the time the US of A was a manufacturing center, these natural resources had a tax trail. This tax trail was from the time it was harvested/dug to the time it was included in the final product. Government debt is related to spending and tax revenues. In other words, moving the manufacturing floor to China and other low wage countries has, in effect, removed the tax revenues from the US of A’s natural resources. I’m a physicist and I believe that currency flows have to be balanced. What goes in must equal to what goes out.
Currently this balance is due to the increase of US of A’s land value. I do not believe that home owners will take equity out of their homes to pay for healthcare, gas and food. Doing so will be irrational and I do not believe that US consumers are irrational with respect to their homes. (I could be wrong)
The previous paragraphs suggest a way to credit the expanded communities’ output. One can tax the exported raw materials, which is not done currently.
Delphi’s Chairman has stated that US of A’s work force is in direct competition with others. If one goes back to the arguments of NAFTA one will see that there was a concerned that the US of A work force NOT compete directly with low wage work forces and that education is the key to maintain the US of A’s competitive edge. The recent report on the ranking of the US of A’s higher education system shows that the Bush administration has failed on both fronts.
I believe that I was successful in placing the business cycle directly in the neoclassic theory for production. It is too late to go back. It is not too late to remove those tax policies that have only resulted in repatriated money going into buying back stock and in the bonuses of top executives. I believe that any government spending that bypasses Wall Street and goes directly in to the hands of the community, specifically, in to the hands of small businesses will work. Tax policies should be targeted for seeking out and maintaining the US of A’s work force. I believe playing by the “golden rule” would give allow the time necessary for the US of A’s work force to be retrained. I also believe that the US of A has to move toward a “universal healthcare” system.
It was Gephardt, I think, who said that the US of A must accelerate the inclusion of the global work force. I believe that a business model that has a cultural bias will be successful in increasing the global GDP. A business model that is cultural biased will also remove the sting of US of A’s work force’s backlash. The Bush administration must now recognize the importance of the Internet and must allow the evolution of the US of A’s work force. This is the only way out of the structural problem this country is facing. It is also the reason why the Federal Reserve must become the leader in global stability.
Watch the $dollar.

Federal Reserve and Monetary Policy: Energy, Substitution and Who's Going to Pay for this?

Greenspan comments of a flexible economic system is, in my opinion, an ideal case. I'm amazed at Greenspan's admiration of Adam Smith's “Wealth of Nations”. (Here's the link ) The biggest problem with Smith's works is that he makes no reference to “Third World or Developing Countries”. This is his view of Colonies:
“The colony of a civilised nation which takes possession either of a waste country, or of one so thinly inhabited that the natives easily give place to the new settlers, advances more rapidly to wealth and greatness than any other human society.
The colonists carry out with them a knowledge of agriculture and of other useful arts superior to what can grow up of its own accord in the course of many centuries among savage and barbarous nations....”

The world is different now. Greenspan's ideal economic system is just as utopic of Owen, Marx and the Fabian socialists. This is a shame because a free market has no business being involved with China's Communist government and its command economy. Greenspan's view on China is in direct conflict with his views on a flexible economic system.

Greenspan has stated that the US economy is on a firm foundation, however, his concern with the housing market is a sign that there is a problem. Katrina has shown, in my opinion, the weakness of the incomes of US consumers. The sharp rise in energy prices is just the tip of the economic iceberg the US economic ship is heading toward. The global financial system is under stress, due mainly to China's command economy. The global market needs clear price signals to re-allocate its resources to meet the needs of the US. A very large dollar amount of investments must flow into the US to rebuild the Gulf coast. China is a investment “Black Hole”. The global financial community have no real ideal of what is happening to “their” investments.

Greenspan, White House economist and others have stated that there is no national housing bubble. It is possible to have a “sink hole” or economic shocks that “liquefies the ground” on which the US's economic foundation is on. This “sink hole” is the result of problems with the global financial plumbing. Its nature is the fact that portfolios are stress tested for interest rates, but not for connections that are part of the plumbing.

Example: Fannie Mae and Freddie Mac's accounting problems can lead to a reduction of home values in the secondary mortgage market. This in turn can shut off some of the financial instruments used to finance a mortgage. This in turn will lead to a reduction of housing activity, in areas that depended on them. Which in turn will be reflected in the housing data. Which in turn will result in a hesitation of capital spending. Which will result in a reduction of GDP. Which will go on and on....

The banking and hedge fund world needs to understand that part of the US “Banking” industry was wiped out by Katrina and Rita. The part of the US “Banking” industry I'm referring to are home values. A region's value has been destroyed and it is up to the US government to bail that region out. Sort of a FDIC for the landowners. Let's face it, the insurance industry is NOT going to pay for the water damage. This is a good time for the coastal regions to set up a catastrophic insurance funds because the rest of us will not bail them out the next time a hurricane comes. Technically, the cost of insurance should drive some home owners out of the region.

The spike in energy cost will force the true nature of some of the economic statics out in the open. Wages and incomes are not what they seem. The US economy is being forced down a path of serfdom and feudal lords. If you do not own a home, you are disfranchised by the White House and others. Rowing back wages only reinforces my concept of the link between US government deficit and the trade deficit (see my blog: Neoclassic Theory of Production). The source of the US's protection against inflation is also the source of the rapid unraveling of our income. As the current account deficit goes up, income must come down. One only needs to look at the auto, airline and now the survivors of New Orleans and other coastal regions to prove it. Bush repealed the prevailing wage law.

Greenspan is right that a flexible economic system will allow the global economy to expand, however, this expansion is at the cost of the US economy which is currently being flushed down the toilet.

I agree that energy prices will spike this coming winter, however, I'm not in agreement to the percent. Consumers will begin the substitute phase during the winter. My mom and sister bought electric space heaters (on my advise) not because I believe that their will be shortages of natural gas, but because the cost per BTU between electricity and nature gas will narrow and it will become cheaper to heat by electricity rather than natural gas. A period of sun, space heater and lower than average furnace usage will, I think, average out to a lower cost than sun and furnace use and still maintain a comfort level. My what a year can do to prices. (if any body agrees with this, I suggest that they part with their money now before a shortage of space heaters become evident)

The only way out of the “rebuilding of New Orleans and who's going to pay for it” peril (sinking of the US economic ship type peril) is to go into deficit spending. This is the “good” type of spending. It will be a direct shot into the local economies and in fact will prevent the US “Banking” (home values) industry from collapsing, aka 1929 ish.

As a side note to those who believe that the refining capacity problem is due to environmentalist, I have a few words: I went to Roosevelt High School in East Chicago, Indiana (look at the Indiana map). Down pass a one and a half block wide city park and across a barge canal (that had a history of catching on fire (the canal)) was a refinery. It is a wounder that I know how to use this blog, because of the smell one gets on a light, breezy day. Environmentalist are right on this issue.

Federal Reserve and Monetary Policy: Katrina and the Fed

The editorial staff at the Wall Street Journal should be “boiled in oil”. Painting the economic landscape with a “very wide gouging” brush just shows what a bunch of amateurs they are. The price signal gouging sends has different meanings depending on whether the product and/or service is elastic or inelastic. The very definition of elastic, in the economic world, means that it is easy for consumers to substitute product B for product A if product A's price is too high. Gouging with respect to elastic items is, in general, a test of price.

It becomes difficult to gage whether gouging sends the correct sign with respect to an inelastic item. One must know the distribution of the items uses. Example: The current housing boom has force the consumers to look for affordable housing outside cities. If there is a large percent of those who drive, live in the large metropolitan areas then the demand for gas is very inelastic (with respect to that group). Consumers' behavior is also effected by duration.

It also become necessary to determine if the consumer has the ability to switch from car A to car B. Buying a new/used econo-box may not be an option. In this case, demand can not decrease. It is better, in the long run, to have prices trend up. This price signal gives consumers time to make the adjustment. The Federal Reserve's Beige Book is indicating consumers are changing their spending behavior.

The current gas situation is not a long term event. The price signs have gone out and laws have been changed to allow the reallocation of global resources to proceed. The US of A imports about 40% of its oil now. Price gouging, with respect to refined petroleum products, sends the wrong signal. There is no global shortage.

I think Wall Street Journal's editorial staff is trying to proect the oil companies. The oil comapnies need no protection. I also think the staff do not give enough credit to the people of the US. We do not need propaganda to car pool. An empty wallet is all the signal that is needed.

Note the use of “GLOBAL”. The US of A is in a global economy, whether people like it or not. The global economy needs the unhindered flow of BOTH currency and INFORMATION. The information that there was a disruption of refined products in the US of A was all the global market needed to begin the process of reallocation global resources. The information the Federal Reserve's Open Market Committee needs to make a decision on short term interest rate is being transmitted by the price action of US Treasuries, the U$ Dollar and the fact that corporate bonds have not tanked.

Long term bonds are signaling that in inflation and inflationary expectations are contained (in the US of A). The dollar has held up. It is signaling the dismay of the global financial market that the US's current account is going to be somewhat of a problem, however, the current trend and sentiment of the dollar index is indicating that there is inflation and inflationary expectations globally. The Fed needs to watch the primary brokers. The watch words are “availability of credit” and “credit quality” (credit is a important as the M2 money supply).


Katrina is an event that can expose the weakness of the Employment Situation Report. If this report has flaws, which is my opinion, Katrina's aftermath will expose these flaws. If Katrina's effect blows through the Credit Derivatives Market and or Hedge Funds World, then the US economy is in big trouble. The housing boom was responsible for 50% of GDP this and last year. The Credit Derivatives Market and Hedge Funds World are the place were credit issuers protect them self. These markets are also the place were airline hedge their fuel cost. In general, these markets are use by companies to hedge their cost. There may not be a Long Term Capital operating, however, there can be many hedge fund companies that can get into trouble and add up to a Long Term Capital problem.

Federal Reserve and Monetary Policy: Chaos and Control

The Federal Reserve has been selling its US Treasuries. This action, coupled with raising short term interest rates has one goal: to control inflation and inflationary expectations. There are two targets that is in the Fed's cross hairs; $dollar denominated commodities and the “funny money” housing has generated. Unlike the Federal Reserves ability to control the “irrational exuberance” of the dot com bubble, the Fed can control the “irrational exuberance” of the US housing market and $dollar denominate commodities.

The Fed is controlling States and Local governments from making future promises, aka California, based on current values of the “funny money” houses has generated. This is very dangerous because inflation (or more specifically the home buyer's perception of the property's value) is needed to maintain the value of the property (or “funny money”).

The $dollar is currently indicating the US has, on the surface, fixed its “structural problems”. If the $dollar weakens against major currencies, I think this is an indication that the “global” financial markets have made the decision the US's “structure problems” have not been addressed. The “funny money” that housing has been generated needs to be propped upped (a re-inflation event).

The market has baked in Alan Greenspan's appearance on Capital Hill, however they have not baked in his probable response to the Chines government's attempt to buy an American oil company. It is going to be interesting how a “free market” central banker is going to weasel out of this given the fact that this certain central banker had given a speech about energy and specifically natural gas. Would you like to guess what the nature of this particular oil company reserves are in the Asian regional? Give yourself 10 points if you said natural gas. Greenspan has to balance his view that government should not go down a “protectionist path” to that of having the American people believe that the US government has sold out to the Chinese Communist government.

Federal Reserve and Monetary Policy: How does the Federal Government balance its books when there are 2 CIAs?

Does it not strike one the oddish way “intelligence” seems to work during Bush's first term?
The CIA tells Bush that Saddam Hussein recently sought significant quantities of uranium from Africa. However, CIA Director George Tenet says the Niger uranium claim should have been left out of the State of the Union speech.

Robert Novak tells the “CIA” in July 2003 that he is going to write that Wilson's wife, Valerie Plame, is a CIA operative and suggested sending him (Wilson) to Niger. In September, the CIA requested, the Justice Department launches a criminal probe into the leak of Plame's identity.
There appears to be 2 “CIAs”. I wonder if that “other” “CIA” is Rumsfeld's Pentagon's “CIA”? I wonder how long the Pentagon's “CIA” was in operation?

“Rove told the grand jury that by the time Novak had called him, he believes he had similar information about Wilson's wife from another reporter but had no recollection of which reporter had told him about it first.”

Question 1) What did Rove do when he was told that a reporter had information about a CIA operative? Did he tell his Boss (BUSH)? If he told Bush, then what did Bush suggested he do? Did he tell the CIA? If Rove told the CIA, then which “CIA” did he informed? Did Rove informed the FBI? If that were the case, then why is this investigation in its second year? As far as we know, Rove blabbed to another reporter (Cooper).

The general gist is that Rove did not believe that particular information was of importance that required him to keep it “close to his chest”. If this was the case, then shame on Rove, but a bigger blame is to be placed on Bush for not taking action (firing Rove). This means that Bush lied to the American public and that the Downing Street Memo was correct.

If Bush was informed and he gave the OK to play politics with a CIA operative then this again shows that Bush lied to the American public and that the Downing Street Memo was correct.

Novak said that there were two Bush administration officials. Since there is no news coming out of the White House, I'm going to stick my neck out and wonder out loud if that other official worked with the Pentagon and it was that person whom Rove told (that other “CIA”). Bush is in charge of the White House, supposedly. Which means, again, that Bush lied to the American public and that the Downing Street Memo was correct.

Question 2) Why is it that the CIA missed the UN's Food for Oil program scandal? Or did they? If I was a intelligence analyst, notice I did not say “a CIA” analysis (under the Bush administration, the CIA are a group of morons), I would have loved the opportunity to get an inside track that such a program would have presented. The oil for food is a direct channel into Iraq. Such a channel would have been priceless if one can use blackmail to gain information. Hence, a very good reason why the police force and intelligence should remain separate. One would want to bring violators to court, the other wants to pump as much information as they can.

It looks like Bush did know that the intelligence gathered on Iraq, was faulty, but ordered the invasion anyway. The faulty intelligence was in fact within the White House, common denominators are Rove and Bush. If Rove knows that the value of intelligence was not worth keeping it to himself, then Bush knows that the intelligence was faulty. Hence, there is a cover up at the White House and Bush is that common denominator.

This political event has just begun. It is time to price some risk into this market. Partisan bickering is going to spill over into the Supreme Court nomination. These two events will combine to suck the “drive of doing the Peoples' business”. This “Leak” from the White House will be carried over into the 2006 election year.

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Update July 15, 2005

“The July 11, 2003, e-mail between Rove and then-Deputy National Security Adviser Stephen Hadley is the first showing an intelligence official knew Rove had talked to Matthew Cooper just days before the Time magazine reporter wrote an article identifying Valerie Plame as a CIA officer.”

“Rove told the grand jury that by the time Novak had called him, he believes he had similar information about Wilson's wife from another member of the news media but he could not recall which reporter had told him about it first, the person said.”

The question remains; What happened between the first time Rove was informed by this forgotten media person and Novak. There are a lot of holes in this saga.

I bet you the leak came from the Pentagon. Why not? Rumsfeld was in Bush senior's administration during the first Iraq war. A war that a lot of people thought ended too soon. The Pentagon was gathering intelligence about the weapons and strength of Iraq's forces. They knew that there was no WMDs. Rumsfeld saw a chance to settle a dispute once and for all. Wilson's information was an obstacle toward that goal.

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Update July 16, 2005

If the information came from the State Department, then the question becomes who is that forgotten media person. Was that media person Judith Miller?

If one believes this article's information “The memorandum was sent to Colin L. Powell, then the secretary of state, just before or as he traveled with President Bush and other senior officials to Africa starting on July 7, 2003, when the White House was scrambling to defend itself from a blast of criticism a few days earlier from the former diplomat, Joseph C. Wilson IV, current and former government officials said.”

The crucial question is now one of “TIME”. When did the leak happened? This is crucial because one should believe that Powell should have been informed before Wilson's trip, not a year later. This implies that Powell was out of the loop. This also implies that the State Department is being used as the scape goat.

I think this is the reason why Miller is sitting in a jail cell. The judge has stated that this is a plot against Wilson.

We are again back to the original question, where did this leak begin. The State Department is now a link, the question can be asked if this was a plot to discredit Powell? We know that there was infighting between State and Defense (Powell and Rumsfeld). Stay tune.

Federal Reserve and Monetary Policy: Obstruction of Justice and Its Accompanying Uncertainty.

Let's stop pussy-footing and call Rove leaking a CIA operative what it is:”It is obstruction of justice by the White House to prevent a high ranking adviser (at that time) from embarrassing the President during an election year”.

Whether Rove broken the secrecy law is not the issue. The issue is whether he leaked “intelligence” for political gain ( fraud and conspiracy). It is also important to track Rove's motivation. Remember, at the time of the leak, the US had ground forces in Afghanistan and Iraq. Leaking this intelligence puts the “spot light” on Bush and his ability to control the situation. Rove leaking this intelligence shows, in my opinion, the complete lack of control that was necessary for Bush to lead the war in Iraq and it certainly shows Bush's desire to force a conclusion of his family's vendetta against Hussein.

One does not leak any intelligence during a time of war. Bush's recent commits of “going forward and bringing the war to the terrorist” now takes on a different meaning. No wounder our “former” allies are afraid of Bush. Bush's comment, means we should be invading Europe.

The political fallout is in the “warm up” phase. Wall Street does not like uncertainty. The political fallout will be on peoples' minds and will affect the “Goldilocks” scenario that some have viewed the US economy to be in.

Federal Reserve and Monetary Policy: Oil's Well That Ends Well

Watch the $dollar. If corporate profits suffer because of the recent strength of the $dollar AND if this forces them to begin cutting cost to meet Wall Street's expectation AND the $dollar weakens, the Federal Reserve will stop. If corporate profit suffer, but margins are stable AND the $dollar breaks old levels (example: 117 Euro) then the Federal Reserve will continue its course of rate hikes until the $dollar is at par with respect to other major currencies.

Remember, a few hedge funds got into trouble with a bad strategy with regards to the GM and Ford's stock/bond hedge. It is possible that the recent and rapid strength of the $dollar has also blown other strategies. The Federal Reserve must continue its “measure pace”.

The price of oil will determine if the FOMC makes an other move on short term interest rate in its August meeting. The key to understanding this is to look at the $dollar index (see: Monthly $Dollar Index). When oil first approached the $55 range, the index was around 86 (June, July and Aug of 2004). The summer soft patch. The index was ranging in the low 80's during the first half of this year. It is now at 86. Turn your attention to the reasons that were given for the price of oil last year: the weak dollar along with global event risk. The excuse given during the first half of this year is based on capacity concerns. Now the excuses are again global event risk and capacity concerns. Notice what is missing, its the weak $dollar (as measured by the index). Let's add in a probable revaluation of the Yuan this summer(?) China pegged its currency lower than the US $dollar, which in turned made $dollar denominated commodities MORE expensive for the Chinese. If China revalues the Yuan by the rumored 10%, this in effect, will be a sharp drop of commodity prices in China. If this drop in prices reaches the Chinese consumers, then it becomes a certainty that the demand for commodities, like oil, will INCREASE (increase in demand). This becomes a problem of price stability for the Federal Reserve.

Federal Reserve and Monetary Policy: Price Stability

There are now two big questions facing the US economy:

• Is the 10 year US Treasury yield signaling inflation and inflationary expectations are well contained or is it signaling a global slowdown?


• Is China good or bad for the US in general?

I personally think the 10 year Treasury yield is signaling a deflationary period in the near future. In other words, I do not believe the wage data coming from the Bureau of Labor Statistics. Let's look at reality;

1. GM and Ford are going through a difficult period. The US operations of Toyota, etc... pay lower salaries and benefits to their US employees. This is now forcing GM, Ford and Chrysler to do the same. This is a deflationary event.
2. The US automakers are also forcing their suppliers to use cheap labor markets (currently China). This is also a deflationary event.
3. The legacy airlines forced wage and benefit concessions from their employees. This is also a deflationary event. It is to be noted that these airlines are still losing money.

I do not think the BLS's estimate of wages from the establish survey is accurate with respect to the US as a whole. It is only good for those companies that responded to that question in the survey.

Does the Current Population Survey provide any guidance? If you read the the methodology at: Technical Paper 63RV: Current Population Survey - Design and Methodology, issued March 2002 (in PDF format)
Chapter 11 page 168;
“The separate accounting of net undocumented migration cannot be based on registration data because, by definition, it occurs without registration. Research conducted at the Census Bureau (Robinson, 1994) has produced an allowance of 225,000 net migration per year, based on observation of the late 1980s, with the universe confined (appropriately) to those counted in the 1990 census. This number is a consensus estimate, based partly on a specific derivation and partly on a review of other estimates for the same period. The derivation is based on a residual method, according to which the number of foreign-born persons enumerated in 1990 by period of arrival is compared to net legal migration measured for the same period. Currently, all Census Bureau estimates and projections of the population after 1990 incorporate this annual allowance as a constant.”

I say the methodology tells all; An illegal population migration of 1 to 3 million is substantially more than the 225, 000 net migration per year assumed in the current population estimate. The household survey is a waste of tax payers money. A side note: HR 53 is one of those damn if you do, damn if you don't type of legislation. HR 53 wants the Census Bureau to count US citizens. Unfortunately, public services are being provided to illegal aliens because they are part of the current census. If only US citizens are to be counted, then Federal monies will dry up because these monies are divided based on the Census data.

It is my opinion that the reason why the US hits a “soft patch” in the economy when oil is above $50 a barrel is due the weak income of the US consumer.

The US economy is in the hands of the global derivatives market. Unfortunately for US citizens the derivatives market is, in general, a secretive market. If any thing bad happens in the derivatives market, we will not know about until it is too late.

In my previous post (See the Neoclassic... and previous post; Federal Reserve and Monetary Policy: A Bubbling Crude, Definitely Not Texas Tea), I stated that China is a crises and that they want Californian. I stand corrected. China only wants a mine in California. What they really want is Alaska and a few miles of sea floor in the Gulf of Mexico.

I personally do not think Chine has been helping with the North Korea nuclear crises. I find it highly probable that North Korea tried to test its nuclear weapon, but it failed. Their coming back to the 6 ways talks, nay, their talking about going to the 6 ways talks is a ploy for time. Once they successfully test their nuclear weapon, they will blame the Bush administration for not agreeing to “one on one” talks.

Bush has no intention in pulling out of the Middle East. In fact, if one analysis BushCo's fiscal and foreign policies, one can get a good grasp that Bush has been telegraphing his intentions of expanding the “Holy War” in the Middle East. This is an unfortunate outcome of spending billions of US taxpayers money “wagging the dog”.

Federal Reserve and Monetary Policy: The Nazi War Machine

In a speech dominated by the tragedy of Sept. 11, Vice President Dick Cheney told graduating cadets at the Air Force Academy on Wednesday that they will help lead the nation to victory in the war against "freedom's enemies”.

Notice the change in ideology. We went from “leading the nation to victory in the war against terrorist to "freedom's enemies”. In other words, be prepare for the following unilateral actions taken by Bush. No troop withdraw from Iraq and Afghanistan. Don't be surprise if US tanks move into Iran and/or Syria. Look for a military build up in South Korea. What ever happened to reaching out to the rest of the “freedom loving countries” and getting some help?

BushCo. wants CAFTA to pass so that they can remove a large chunk of foreign aid from the US government budget. BushCo is using fast track authority to remove the production of consumer items from the US economy and replace the production of those items with guns and bullets. In other words, no President Johnson's “Guns and Butter” society.

Price stability is going to be hard to maintain once our trading partners find out that BushCo. is not interested in diplomatic solutions for Iran and North Korea. It will be a fight between the US current account deficit and the slow down in the global economy. Throw in a mixture of geo-political risk and poof, dollar volatility!!!!

Price stability is also going to be hard to maintain after the statement of Dallas's Fed President Fisher saying that the Fed is in the 8th inning with respect to interest rates tightening. In other words, the FMOC members are hoping that recent dollar strength will translate into lower import prices and corporate profits grow due to lower cost and/or increases in the top line.

It was always my opinion that Greenspan's foray into political topics has placed the Fed in a difficult position. Fisher's interview has confirmed this opinion. He said that the Federal Reserve does not understand the dynamics of today's economy. If the fed has no ideal want is going on, then how is in the best interest of the citizens of the US that Greenspan can endorse permanent tax cuts, SS and other fiscal items?

Federal Reserve and Monetary Policy: Would you like Freedom Fries with that order?

France did not go for the current EU constitution. I guess this means that it is the end of the world as we know it. The US's trade deficit is going to explode because of the lack of trade that some of the proponents of the constitution pointed at. Oh my, the Federal Reserve's monetary policy is in ruin. BushCo. is going to blame the every widening trade deficit on Newsweek, whoops, I mean they'll blame it on France.

This is, of course, not my opinion. I think 54% of the citizens of France analysis what was happening across the pond and decided they wanted no part of it. Not only would the EU constitution have devastated their Socialize Society, but it would have also meant a few trillion francs of private debt, a few trillion francs of government debt and a few trillion francs of trade deficit. France could have looked forward to a few million, uncontrollable illegal and legal alien migration. It would have also meant that France's economy would be dependent on an unregulated, global credit derivatives market. France does not have the benefit of a few multi-billion francs that a few hurricanes can release from various insurance companies directly into their economy.

I guess what they really wanted was not to lose control of their government.

Federal Reserve and Monetary Policy: A Bubbling Crude, Definitely Not Texas Tea

Too much froth in the housing market. Greenspan has said it. It was mention during the FOMC's May third meeting. Atlanta Fed Bank's Jack Guynn
Continuing the Pattern of Growth and Low Inflation Certified Professional Home Builder LuncheonAtlanta, Georgia May 25, 2005
has also said it. So, what is the problem. I think the question should be “what are the problems”?

There are two problems that a linked.
Problem number 1: the buying and selling of dwellings not yet built. This is a “futures” market. Also, one can throw in the buying and reselling of existing homes. As in any futures market, the future price is dependent on the value of the property, the value of the US currency and the expectations of the future buyer's that the property will not lose its value. In general, the housing market is not subject to violent price swings, but it can be if the underlying link is also in flux.

Problem number 2: Creative financing of homes. Again, this is not a problem on to itself. Creative financing dependents on the expectations that the home buyer does not run into financial trouble as he/she occupies the home. Again, no problem as long as the link is not in trouble.

The Link is the $7 trillion dollar derivatives market. Corporations that finance the housing market use the derivatives market to protect themselves against prepayments, defaults and interest rates movements. Unfortunately for these corporations, the derivative market is also home to other players that are in it for the short term gain due to some sort of a price mis-match or a counter bet. If these players get into trouble, the link is in trouble.

Can one deduce if there is a potential problem based on just one event? I'm going to say yes. One can point to the rumored problems of hedge funds that were short on GM and Ford's stock, but long on their bonds. The credit down grade supposedly caught them by surprise. One can key on the knowledge that their bonds were going to be downgraded. Why did they not pull out of the trade? Were they looking for some sort of information that they thought was going to be announced (or leaked) before the down grade? Were they looking for pricing level? This tells me that a lot of fund managers do not understand the “business” of business nor the mathematics of the instruments they use. One should expect more rumors of hedge funds in trouble as the months progress. This is due to the fact that the Fed is raising short term interest rates. The removal of the carry trade always causes trouble.

It will be really funny if California (the state) declares bankruptcy due to poor bond structure (Orange County, Cal.) and those who hold interest only mortgages to lose their property and then find out that China owns a large part of southern California because they hold the deeds.
My expectations for the future of the US economy. The third quarter is going to be below Wall Street's expectations. Activity in the first and second quarter is due to tax refunds being sent and spent. This stimulus will not be in play during during the third quarter. It will be vacations over shopping. The fourth quarter and the year's GDP will be made if four hurricanes hit the high population regions of the southern shoreline (it took four last year). One or more making landfall in the swamps, will be the starting gun for excuses and finger pointing on Wall Street and Washington DC.

There is no phantom job market. There will be the usual Equity to Liquidly being substituted for labor in GDP ($700 billion worth). Mortgage rates may be low, but the cost of closing the deal will increase because of the cost of the US currency will be higher (US dollar strength). The cost of risk management will also be higher due to a decrease in the number of willing buyers.

All bets are off if there are problems in the oil pits or if there is a major meltdown in the derivatives markets.

Federal Reserve and Monetary Policy: A Sticky Situation

Greenspan's conundrum still has no explaination. I think it is related to the housing market. One needs a change of perspective to understand this. The current thinking is that housing value is related to labor's income. In other words, the Neoclassic Theory of Production's output function can be written as Y = f(L, K, I) where Y is the output function, L is the labor number, K is capital and I is investment.

Labor produces wealth by depositing their wages into the bank which in turn generates more wealth. We know that people are taking equity out of their homes by various means. The equity to liquidly processes must be the mechanism by which Greenspan's conundrum is based. The equity to liquidly process is independent of the labor force (my opinion, no proof), yet it adds to output. The equity to liquidly process is also independent of a home's price (the value of the credit received is dependent , but not the actual process of equity to liquidly). Therefore, the production function can be written as Y = f(L, K, I, E-L) where E-L is the production factor due to the Equity to Liquidly process. In other words, the E – L factor term has its own supply and demand curves and the equilibrium is set by the intersection of these two curves. The E – L factor is independent of labor, capital and investment which are the conditions for usage in the Neoclassical Theory of Production.

The Equity to Liquidly factor has the time span of home equity line of credit time span or short time span reqire to recoup a housing investment (flipping etc...). This is the new constraint on how interest rates are distributed (the shape of the yield curve). One can use a production function of the following: Y = f(L, E-L). This production function has an L, E-L isoquant. The L, E-L has an elastic substitution function.

The biggest problem with this process is that the lenders use various neutral risk strategies to protect themselves. As interest rates rise, so does the cost of these neutral risk strategies. This is were the problem is in the housing market. It is not that the price of homes have gone up, it is the fact that Equity to Liquidly process is at risk of failing due to failing hedge funds or a reduction of risk exposure.

There is a connection between GDP and the Equity to Liquidly process. If the E – L process produces less output, this in turn will decrease GDP. A lower GDP will reduce demand for housing which will decrease the demand for E – L. So on and so on... If the Federal Reserve steps on the US economic brakes too hard, they will cause a melt down in the hosing market due to a lack of funding for the neutral risk strategies which in turn will cause Fannie Mae and Freddie Mac to go to the US Treasury to bail them out.

Greenspan has, yet again, repeated his opinion that there is no risk in the GSE which makes them ripe for a hard fall. If Fannie and Freddie are forced to reduce their ability to function in the secondary market and if the other financial companies also reduce their exposure to the housing market, then it is “good night” for the US economy and hello “soup line”.

Federal Reserve and Monetary Policy: Hands Across the Ocean

Treasury Dept released its Report to Congress on International Economic and Exchange Rate Policies May 2005
a major blunder was this part:
“While China’s ten-year-long pegged currency regime may have at times contributed to stability, it no longer does so. The peg blocks the transmission of critical price signals, impedes needed adjustment of international imbalances, attracts speculative capital flows and is a large and increasing risk to the Chinese economy. Indeed, Chinese officials have publicly acknowledged the need to move to a more flexible system, have repeatedly vowed to do so and have undertaken the necessary and appropriate preparations. It is widely accepted that China is now ready and should move without delay in a manner and magnitude that is sufficiently reflective of underlying market conditions. Treasury will continue to engage with China and closely monitor changes in its foreign exchange policy over the coming weeks and months.”

The peg of the Yuan is about 40% less than the dollar. This means that $1 billion dollars invested in China is worth $1.4 billion in China. I say that this gives US mega-corporation 40% more of incentives to STOP China from floating its currency. From a Neoclassical Production, Growth and Distribution theories, China is a “BLACK HOLE” with respect to US investments. China is a crises from an economic stand point that the free market mechanism of the US economy can not deal with.

The Bush administration is hopping that China will intervene in the North Korea nuclear crisis. China has refused to put pressure on North Korea and blames the Bush administration for “stirring up the mud”.

Are we getting our money's worth out of China. Let's see: they refuse to help on the North Korea nuclear crises. They refuses to “isolate” North Korea to get them back to the 6 way talks. Yet, we are sending them billions of dollars in trade and they still have not revalue their currency. China holds hundreds of billions of dollars in US Treasuries. Yep, China has reached out across the ocean and has Bush's throat with one hand and a firm grasp on the wallets in US mega-corporation pockets with the other hand. To be fair, Bush has his hands in those same mega-corporations' pockets with a firm grasp on the same wallets.

There is no way the Federal Reserves Monetary Policy can stabilize the US dollar against other major currencies. India and China are US investments drains due to their large population/labor force. The continuing upward pressure of inflation (slow, but steady) is going to place US corporation in the fire of Wall Street's expectations. It's going to take another 4 major hurricanes making landfall in high density population regions to make GDP goals. High, costly, impact events are needed to transfer money into the US economy now days. See link: Damages and Insurance Settlements for the Third-Quarter Hurricanes Third quarter 2004. If it wasn't for the direct infusion of $105.2 billion dollars into the US economy, GDP will have never been as high as it was reported for 2004.

It is only a matter of a few months before Fannie Mae and Freddie Mac forces the US Treasury to buy their bonds and bail them out of a cash flow jam. Shareholders will be walking away with their dividends, of which neither GSE had cut, while Wall Street and Washington DC. blame each other. Those of us on Main Street can only watch as the US economy is flushed down the toilet. Events like this happens when hedge funds goes belly up and there are no buyers of the GSEs' options, swaps and other neutral risk instruments and strategies.

Side note, see link: Fannie Mae's 2004 10K page 20.
“Our charter authorizes us, upon approval of the Secretary of the Treasury, to issue debt obligations and mortgage-related securities. At the discretion of the Secretary of the Treasury of the United States, the U.S. Treasury may purchase obligations of Fannie Mae up to a maximum of $2.25 billion outstanding at any one time. This facility has not been used since our transition from government ownership in 1968. Neither the United States nor any agency thereof is obligated to finance our operations or to assist us in any other manner. The Federal Reserve Banks are authorized to act as depositories, custodians, and fiscal agents for Fannie Mae, for the Bank’s own account, or as fiduciary.“

Fannie Mae and Freddie Mac are TBTF. (Too Big To Fail)

Federal Reserve and Monetary Policy: Elvis has left the building

The Federal Reserve has just come out with CREDIT RISK MANAGEMENT GUIDANCE FOR HOME EQUITY LENDING

Note, this is for guidance note requirements.

There are rumors of hedge funds in trouble because they were caught off guard when Ford and GM's bonds were down graded to junk. It doesn't take much to scare off new buyers of securities. It also doesn't take much to remove old buyers from the bond and credit derivatives instruments. The Federal Reserve has released a survey of credit risk management, see The January 2005 Senior Loan Officer Opinion Survey
on Bank Lending Practices

and Greenspan has made a comment on risk management, see Remarks by Chairman Alan Greenspan Risk Transfer and Financial Stability To the Federal Reserve Bank of Chicago's Forty-first Annual Conference on Bank Structure, Chicago, Illinois(via satellite) May 5, 2005

I think it is too late. The removal of the carry trade has already cause trouble in the derivatives market. See Federal Reserve and Monetary Policy: Federal Reserve's Challenge for my reasons why I think that the problems in the derivatives markets are going to blow through the Fannie Mae and Freddie Mac back door.

It also doesn't help if the US can not attract the foreign investments to cover the trade deficit. $45.7 billion, down from $84.1 billion, but not enough to cover the $54 billion trade deficit.

Federal Reserve and Monetary Policy: Fraught with Contradictions

Remarks by Vice Chairman Roger W. Ferguson, Jr.To the Association for Financial Professionals Global Corporate Treasurers Forum, San Francisco, California (via videoconference)May 12, 2005
Globalization: Evidence and Policy Implications
is fraught with contradictions. He cites papers that are no longer relevant in todays economic conditions and he makes comments that he says are good, that reality has be proved to be false. Here are some example that really stands out:
The Pew estimates that the change of Hispanic population for 2002:4 to 2004:4 was 2219. If one makes the assumption that this rate of change is valid for the 2000 to 2002 , then the number of illegal aliens is about (2219 + 2219) x 0.7 = 3.106 million unaccounted for in the Census Bureau data. The Census Bureau do not keep tabs on illegal aliens. This influx of illegal aliens clearly affects the population sample. The Federal Reserve has to use the Employment Situation Report in its communications with those in Washington DC. They know it is fraught with sampling and non-sampling errors. Some of these errors are not corrected for. Every body keeps pointing out on how well the data points to a “strong” job market without pointing out the qualifiers the Federal Reserver speakers plug into their speech: “... the slack in the job market is ...”. This qualifier should give a really big hint that things are not as they seem.

Here is another dozy.
“Economists who have studied rising income inequality in America generally conclude that, although international trade and migration have contributed slightly, the main factor by far has been progress in information technology, which has boosted the demand for educated workers relative to those with low skills.“

“Yet another potential implication of globalization is that the distribution of incomes across countries will shift. Professors Edward Leamer of UCLA and Peter Schott of Yale have recently suggested that the significant gains in Chinese and Indian per capita income over the past twenty years may have come at the expense of income growth in the so-called "middle income" developing countries such as Argentina and Brazil. Per capita incomes in many middle-income countries have stagnated while per capita incomes in the industrial countries have continued to grow. Leamer and Schott argue that few Chinese or Indian products compete with products made in the industrial countries, whereas many Chinese and Indian products do compete with products made in the middle-income countries. This is an interesting and provocative hypothesis, but as yet it has not been subjected to careful testing.”

Yet Dallas fed president has stated this in a recent speech:
“India has become a major information technology and business-processing center for U.S. companies, and jobs are shifting to Bangalore from Baltimore and to Delhi from Dallas”.

That does not sound like India is stealing from “middle-income” countries. The threat to the US economy is not the GDP of China nor India, it is the very cheap labor. It is interesting that both of these officials are trying to say that the US economy is strong and that trade will increase the wealth of US citizens. I guess they haven't heard that the trend of staying in one home has changed and people are now looking to leverage their future wealth in the hopes of striking it big in the real estate market.

The Federal Reserve is now sounding like a bunch of old guardish puppets that I'm going to change my mind about the up coming removal of the carry trade and its impact on the US economy. Greenspan opinion on hedge funds not being a problem is in doubt.

Because of the lack of respect I have for the current Federal Reserve officials, I'm going on record and say that the removal of the carry trade will cause an economic collapse in the US. The problems in the derivatives market WILL blow through the Fannie Mae and Freddie Mac back door and take out the US housing market. This event will force foreign investors to pull their cash out of the US. This in turn will force the Fed to pick up the pace of hiking Fed Funds Rate. This has happen before, except it was gold the Fed was trying to stop from flowing out. A currency collapse is imminent.

See you in the soup line.

Federal Reserve and Monetary Policy: Change the Tune

Bush has made a statement today that CAFTA will promote Democracy in Central America. For me, that statement was what I've always thought. (See previous post) Bush has been using fast track authority as a dodge around Congress to implement his foreign policy. This process has made the job of the Federal Reserve more difficult.

On one hand, this process has made the calculations of how much more the US economy can continue to fund its current account deficit more difficult. See Is the Current Account Sustainable? The term that is at risk is the unilateral transfers (foreign aid). Bush is trying to shift the burden of foreign aid from all taxpayers to the middle class. In other words, income redistribution from the middle class to the poor of those countries. Sounds like the Communism Doctrine is being promoted by the leader of the free nations.

On the other hand, labor arbitrage lowers the income in the US and makes the job of forecasting inflation and inflationary expectations more difficult and less accurate.

Federal Reserve and Monetary Policy: Trade is Protectionism

Dallas's Federal Reserve Bank's President Fisher's speech is an indication that this president has know ideal what the US economic future is. He has this to offer the US citizen:

“I am convinced that India would not have gotten on the ball if it were not for the example of China. India has been growing at a 7 percent clip, though for a shorter time. It has some disadvantages that China does not suffer from—a lack of gender equality, an underdeveloped educational system for the masses and the lingering problem with castes. But it has some enormous advantages in addition to a colonial legacy of widespread use of English, foremost among them a respect for intellectual property and the rule of law.

When it comes to China and India, I ask you to think beyond the headlines—beyond the hype—and keep their burgeoning economic miracles in perspective. Measured in dollars, the economic output of China is roughly that of one U.S. mega-state, California. India’s economy is 20 percent smaller than that of Texas.

As fast as China and India are growing, these two countries have a long way to go before they overpower the United States, as some alarmists claim they will. We are a $12 trillion economy. Let’s do the math together. Pick a number of, say, 3 percent for real U.S. growth—well within our recent experience. Just to match the dollar value of our annual increase in production, China would have to grow 21 percent. India would have to grow 56 percent.
That said, it is true that they are growing like “gee whiz”—thanks, to a great extent, to U.S. consumers of goods and services. China’s exports to the United States have doubled since we inked our bilateral World Trade Organization deal and by 1,600 percent over the past 15 years. India has become a major information technology and business-processing center for U.S. companies, and jobs are shifting to Bangalore from Baltimore and to Delhi from Dallas.”

China is a ”COMMAND ECONOMY” not a free market economy. China also pegged its currency to the dollar to weaken it (~40% less). A command economy is an inefficient economy. In effect, it is a monopoly with respect to a free market. The pegged means that China can attract foreign investors because their investment dollar goes 40% further. China's GDP is not what threatens the US. It is the cheap labor.

His India crack just shows he has no ideal how much of the US economic future is pinned on IT. IT was suppose to be the saving pitch for the US economy now that manufacturing is fleeing into China.

CAFTA is a “free trade” agreement. In reality, its is an other labor arbitrage path, the off shoring of labor. See Neoclassical Theory. From a “global work force” point of view, trade (international trade) is protectionism. Trade maintains the GDP of a country. This is in direct opposition to labor arbitrage, which equilibrates GDP.

Federal Reserve and Monetary Policy: Time will Tell

The Employment Situation Report looks good on the surface, however, I find a few items disturbing. Making the assumption that the household data is, marginal, then I can not find anything really wrong. The unemployment rate held steady at 5.2%. The marginal attached labor force, see tables A-12, subsection U-5 went from 6.4% to 5.9% (not seasonly adjusted), 6.2% to 6.1% (SA). This is a good indication that at least for some people, they find that the job creation has picked up. This number is good news if it holds. It is bad news for long term inflation and inflationary expectations because the labor force buffer is apparently shrinking.

The established survey data is worrisome. BLS reports that payrolls grew by 274, 000, but the net birth/death model contributed 257, 000. Secondary evidence such as the duration of the unemployed, table A-9, indicated that with the exception of less than 5 weeks, all of the other time duration has gone down. GDP will indicate whether the 257, 000 is a mathematical artifact. (See "Federal Reserve and Monetary Policy: Greenspan's testimony on Captial Hill was as I feared" for my objections to the birth/death model)

The above analysis assumes that the large influx of illegal aliens has not corrupted the population samples. (see previous post)

At this current time, I will say that the Federal Reserve will raise short term interest rates by 25% at the next FOMC meeting. I will also say that the bond market is still correct in their collective thinking that the long term inflation risk is low.

Federal Reserve and Monetary Policy: Inflation is Well Contained

Is long term inflation well contained? Two key data indicate that this is true (so far). Capacity Utilization is at 79.4% (the fed is usually worried when this number is around 85%) and there is still slack in the labor market. Notice, I did not say that there is inflation and inflationary expectations due to the labor market at full employment. In other words words, an unemployment rate at 5.2% is not the true measure of how close the US is toward full employment. One needs to read the details of the household survey.

See table A-12 of the Employment Situation Report. Subsection U-5: Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not currently looking for a job.

The current numbers are 6.4% not seasonal adjusted and 6.2% seasonal adjusted. Notice that I did not include the part timers who are working part time for economic reasons (9.4% NSA 9.1% SA subsection U-6). I did this because these can still increase inflation and inflationary expectations.

Some peoples' insistence that the household data shows that there is a phantom job market is misplaced. All one needs to do is to read the details of the Technical Paper 63RV: Current Population Survey - Design and Methodology, issued March 2002 (in PDF format). It only takes a wrong population projection to turn marginal data into useless data. Right off the bat, I can think of one error that is not corrected in the population projection. Having 3 million illegal aliens enter this country each year, according to Time, is enough to throw the population samples off.

It is my opinion that the fed is not concerned about long term inflation because the removal of the carry trade will do their job. Fed Funds Target at 3% can be perceived, by some, as the end of free US dollars. The first indication of the removal of the carry trade will be in the commodities market. Prices should fall as no new contracts are picked up because of the cost of the US dollar. The US dollar now has some cost associated with it. Expect an increase in the volatility in the commodities' pits. Also, expect this volatility to spread into the derivatives market.

Watch out for falling rocks. The financial markets are in for an earthquake type ride in the coming months. Well at least it should look like an earthquake if one looks at the graphs.

Federal Reserve and Monetary Policy: Healthcare and Social Security

I was looking at Remarks by Governor Edward M. GramlichAt the Spring 2005 Banking and Finance Lecture, Widener University, Chester, Pennsylvania April 21, 2005
A First Step in Dealing with Growing Retirement Costs

and I got an epiphany. Non of these analysis takes into account the income distribution due to off-shoring. The US is NOT the only country going through this off-shoring of its labor force. Western Europe is off-shoring to Eastern Europe. Just take a look at Germany's unemployment rate. It is inevitable that the cost of the pills and technology will come down due to shear “bulk”. In general, the cost of goods and services have come down. We do not know what the future holds.

Health care, in the US , is going through a transition. Health care cost was broken down into tiny payments to the companies that provided it as a benefit. US consumers who have to provide out of pocket expenses for health care have no way of passing that cost on. This is due to off-shoring and its income distribution. The US went from tiny to big payments.

It is possible, if nothing is done, that the US health care system will become dysfunctional due to lack of critical mass. The only way to save the US health care system is to “Fissure It”. Remove the basic, low risk part of the system from the high cost, high risk sections. If the clinic is a low risk, basic health care provider then they pay a low insurance cost. As long as there is no “criminal activity” the state will guarantee the balance of any increase of insurance premium. The state finds a re- insurer.

Never mind, this is too simple for the powers on Capital Hill.

Federal Reserve and Monetary Policy: “Nuclear Winter”

Republican Senators electing to use the “nuclear option” to pass Bush's Federal judge nomination will, at the very least, be a Constitutional crises. However, there will be a financial cost also. The Democrats has stated that they will shut down Captial Hill. Shutting down Captial will, in effect, start a classic “tug 'o' war” in the global financial system.

The equities side of the rope will probability take it as a positive sign. There is nothing better for equities than the same old policies. Equities love grid lock.

It will be hard to pin down the effects of a dysfunctional Captial Hill on the US Treasuries and the dollar. On one side of the rope will be those who will take it a positive sign. No new spending increases will result in a smaller US government deficit. Those on the other side of the rope will probability conclude that the “Full Faith and Value of the US Government” is too much of a risk.

The ultimate, worst case scenario would be massive social unrest to the point were Bush declares marshal law and sets himself up as the “Fuhrer” of the US Nazi party, formally known as the Republican party.

Federal Reserve and Monetary Policy: “You don't say. Is that right”.

Three Federal Reserve officials saying the same thing: “inflation is contained”.
“It is difficult to explain what has happened to rates. I think the credibility of monetary policy is an aspect," said Pianalto.

Here something to mull over, the 2 year note is lower. Some bond traders think that the Federal Reserve is going to “STOP” raising the fed funds rate. Are they worry about the removal of the carry trade? Is this a flight to quality?

The currency wars continue. The dollar strengthen against the Euro one day because Germany's investment survey came out with a number very far below consistence (“it fell off a cliff”). This raised expectations that EU central bank will lower interest rate.

The next day, the dollar weakens because the PPI data shows that inflation is contained. This information lowers the expectations that the Federal Reserve will not increase the fed funds rate at a faster pace.

It comes down to whether the US can control the ever widening trade and US government deficit.

Federal Reserve and Monetary Policy: Global Trade an oxymoron?

Bernake has the opinion that the US current account deficit and high government debt is the result of developing countries not borrowing, but saving too much. See: Remarks by Governor Ben S. Bernanke At the Homer Jones Lecture, St. Louis, Missouri
Updates speech given on March 10, 2005, at the Sandridge Lecture, Virginia Association of Economists, Richmond, Virginia
April 14, 2005
The Global Saving Glut and the U.S. Current Account Deficit

However, he relies on accounting principles to defend his view. The biggest problem with this tactic is the following: “It can not explain why there is a global savings glut”.

Labor arbitrage can explain it. See Neoclassical Theory of Production.

Federal Reserve and Monetary Policy: “Abra-Ka-Da-Bra, Presto-Change-O, Inflation- Go-Away-O”.

It is amazing what a day can bring in the every changing world of the financial markets. One day Wall Street is up because inflation is contained(?). FOMC minutes was not as hawkish as expected and a the larger than expected trade gap means more cheaply made goods and services-> higher profit margins for all. The next day Wall Street is down because inflation is contained(?). A weaker increase in retail growth, 0.3% instead of 0.7% and a lousy 5 year not auction was just too much negative news fir Wall Street to Stomach. Wall Street has its wish. Inflation and inflationary expectations are in fact contained. Richard Fisher, Dallas's Fed President, made it clear that he is “comfortable” with current pace of monetary policy. BushCo's (lack of enforcment) trade policy, “off-shoring is good for America” and GE's tax breaks should have been enough to blow the lid off of Wall Street.

Is it possible that that “wall of worry” Wall Street is climbing has in fact been made by themselves? Has Wal Street come to the conclusion that their high expectations has be met by slashing the domestic US workforce to the point were real output has been severely eroded? Nah, Wall Street will fall back on their usual excuses. You know; “geo-political risk”, high worker productivity, high energy cost, high commodity prices and of course health care cost and blame every thing on (a Republican control) Washington DC.

“Maybe I ought to get another hat”.

Wall Street shouldn't be surprised that both trade and government deficit are large. They pushed for the supply-side economic recovery package. The reason why the Employment Situation Report is not a good indicator of current economic slack is because off-shoring has thrown this report off. Using the Keynes community view:
"The traditional theory maintains, in short, that the wage bargains between the entrepreneurs and the workers determine the real wage; so that, assuming free competition amongst employers and no restrictive combination amongst workers, the latter can, if they wish, bring their real wages into conformity with the marginal disutility of the amount of employment offered by the employers at that wage. If this is not true, then there is no longer any reason to expect a tendency towards equality between the real wage and the marginal disutility of labour."

Off-shoring has removed the equality between real wages and the marginal disutility of labor. In fact, so has the large influx of illegal aliens and employers willing to hire them.

Is “Globalization and Trade” an oxymoron? The end result of trade is specialization and the end result of off-shoring is income redistribution. With regard to trade, one can ask what are the factors making one country more productive (in a single sector) than another. Neoclassical models are used to answer this question. However, no one has looked into the off-shoring/illegal alien influx effects on US economy. There is the “wave of the hand” type argument that it is good for the economy because it lowers the final price consumers pay.


I'm going to use my blog as a spring board and try to cast the off-shoring/illegal alien effects using Neoclassical model and create some sort of controversy in the economic universe.

See Neoclassical Theory of Production.

Federal Reserve and Monetary Policy: Did You Get A Raise?

Minutes of the Federal Open Market Committee March 22, 2005

The key phrases are “disposable income”, “resource and labor market slack” and “energy prices”. I personal think the consumer spending part is masked by tax refund season and is therefore currently an unreliable indicator for future spending. The income number comes from the Bureau of Labor Statistics. This number is “marginal”, but I consider it useless. See:
Greenspan's Testimony. Highest gasoline prices at the pump before “driving season”, enough said.

Long term inflation and inflation expectation boils down to the labor market. Here is the definition of “economic slack”: defined as the difference between the current level of output and the level of output the economy could produce if all available resources were fully utilized. From Remarks by Vice Chairman Roger W. Ferguson, Jr.
To the Andrew Brimmer Policy Forum: National Economic and Financial Policies for Growth, Employment, and the Improvement of Equity, at the 2005 Annual Convention, Allied Social Science Associations, Philadelphia, Pennsylvania
January 7, 2005
Interpreting Labor Market Statistics in the Context of Monetary Policy

The paper indicates that the Employment Situation Report is currently not a very good indicator of “economic slack”.

The Federal Reserve Monetary Policy is to achieve price stability and full employment. Trillions of dollars in the global market place, Bush's failed trade policies and “off-shoring is good for America” has made the Fed's monetary policy a joke.

Worker productivity and “geo-political risk” are always the fall back terms. I personal think that there is enough evidence that the removal of the “carry trade” is going to cause market volatility. I think the Fed is aware of this. It is my opinion that the Fed is really indicating that they are going to increase short term rates a quarter of a point until the financial markets become dis-functional. Then they will quite.

Federal Reserve and Monetary Policy: The Twin Deficits

See: Remarks by Governor Edward M. GramlichAt the Isenberg School of Management Seminar Series, Amherst, Massachusetts May 14, 2004
Presented at the Los Angeles Chapter of the National Association for Business Economics Luncheon, Los Angeles, California March 31, 2004
Presented at the Euromoney Bond Investors Congress, London, EnglandFebruary 25, 2004
Budget and Trade Deficits: Linked, Both Worrisome in the Long Run, but not Twins

I'm not going to go to much into this. It is a complex subject, however I'm going to apply Keynes implied expanded community to this simple equation (See Federal Reserve and Monetary Policy: Greenspan's speech on Capital Hill was as I feared.) :

Original: NS = S - BD = I – TD

The expanded community the is no Trade Deficit (TD), but there can be a Government Budget Deficit (BD). This means that the National Savings (NS) is the combination of the US community and the off-shored (expanded) community. This same combination argument can be applied to Savings (S) and Investments (I).

I'm going to add a simple production function F(i(1), i(2), ..., i(m)) and use the concave rule: if f(x) > f(x'), then f(yx + (1 – y)x') > yf(x) + (1 – y)f(x') for any y E (0, 1).

In words; The output (GDP) of the US community [f(x)] is greater than the output (GDP) of the off-shored (expanded) community[f(x')]. Therefore the weighted combination of the two “communities” is inside the isoquant of the production function. This is economically inefficient. To bring it back onto the isoquant (technology efficient) and therefore make it economic efficient, one needs to add a condition of throwing away the extra input. I'm going to say that this thrown away part is the US output, hence it is the US's community's “trade gap”. See figure 1.

Figure 1

I'm giving the US community and the off-shored (expanded) community a progressive tax system. There is no tax revenue sharing between the two communities implies that a part of the off-shored (expanded) community's tax is paid by the US community without a reciprocal payment. This implies that the thrown away input is not counted. Therefore, the US trade deficit and the US government debt are in fact twins.

Federal Reserve and Monetary Policy: Price Stability.

It is my opinion that price stability was not achieved by monetary policy, but by off-shoring. I think this is the reason why there is a difference of opinion at the Fed and within the economic universe about inflation. Price stability controlled by monetary policy means that the Fed can control inflation. Price stability controlled by off-shoring means that the Fed has limited control. They can only control US consumers.

Greenspan has made comments that inflation was “contained”. 5 key indicators point to this conclusion; Employment level (measly 2.6 million(?) and a lousy 110, 000 in March), wage increase (2.5% year over year(?), PCE deflater (~0.3%) and Capacity Utilization (79.4%) and the average participation in the food stamp program continue to climb (see: ). Of course, there is the missing $1 trillion dollars (see: Case of the Missing Trillion).

Has the Federal Reserve missed the obvious? Let's take a look at some of the past speeches.
Remarks by Governor Ben S. Bernanke At the Global Economic and Investment Outlook Conference, Carnegie Mellon University, Pittsburgh, PennsylvaniaNovember 6, 2003
The Jobless Recovery

Remarks by Vice Chairman Roger W. Ferguson, Jr. At The Exchequer Club of Washington Luncheon, Washington, D.C.July 21, 2004

A Retrospective on Business-Cycle Recoveries: Are "Jobless" Recoveries the New Norm?
Remarks by Governor Ben S. Bernanke At the Distinguished Speaker Series, Fuqua School of Business, Duke University, Durham, North Carolina March 30, 2004
Trade and Jobs

All of these speeches missed the redistribution of income and investments that Keynes put forth. See:
Federal Reserve and Monetary Policy: Greenspan's speech on Capital Hill was as I feared.

The redistribution effect can explain why incomes are flat, the slack in the labor market, the twin deficits and the continuing problems with GM and now Ford. GM and Ford are going through a lack of output in the US. This lack of output is going to spread into other sectors of the US economy. An example is South West, they are having problems with the high cost of fuel, despite the fact that they have low labor cost.

Federal Reserve and Monetary Policy: Federal Reserve's Challenge

The greatest challenge faced by the Fed is the carry trade. A negative real interest rates (fed funds target – inflation rate) means that the carry trade can effect prices (speculation). It is a certainty that the removal of the carry trade will result in volatility of both US bonds and dollar index. The new financial instruments are going to be stress tested in the coming months.

The 2 financial instruments I'm going to discuss are the credit issued to the sub-prime market through both the consumer loan institutions and through the secondary mortgage market as represented by the GSE's Fannie Mae and Freddie Mac. I will point out the mechanisms that I feel will cause these markets to fail and in turn, affect the entire US and the global market to the status of becoming non-functional.

The credit issuer use credit derivatives and the secondary mortgage institutions uses a form of risk management call dynamic hedging. Both of these risk management strategy requires that both the bond and currency market remain stable and predictable. The removal of the carry trade has always been a dramatic event in the international financial markets. Russia's default, Long Term Capital Management's collapse and Orange County, Cal default are just some of the well know failures.

The major issues that will determine if there is a collapse of the US financial markets can be enumerated:

• How much of the debt is backed by some sort of a hedging strategy.
• How many consumers are at risk of default. Notice I stated on the quantity not the quality of income. It is uncertain on how the resulting instability will affect the job market.
• What is the perceived wealth of the US consumer from the foreign investor's point of view.
• What will the response of the international market to the removal of the carry trade. Herding mentality will increase the volatility of the financial markets.
  
  A starting point to gain some knowledge of the levels of various debt level in the mortgage market can be retrieve from the following: Remarks by Governor Edward M. Gramlich At the Financial Services Roundtable Annual Housing Policy Meeting, Chicago, Illinois May 21, 2004 Subprime Mortgage Lending: Benefits, Costs, and Challenges
  
  The risk to the sub-prime financial system can be gleaned from this paper: MORTGAGE BROKERS AND THE SUBPRIME MORTGAGE MARKET
  Amany El Anshasy
  George Washington University
  Gregory Elliehausen
  Credit Research Center, Georgetown University
  and
  Yoshiaki Shimazaki
  George Washington University
  May 2004
  
  The following is going to be a problem:
  The retail price is the combination of points and contract rate that the broker quotes to the borrower. The borrower typically can choose from a menu of different points and contract rates. The wholesale price is from a menu of loan prices (expressed as a percentage of the loan amount) that the creditor is willing to pay for different contract rates with specific lock-in terms, which is based on the value of the loan in the secondary mortgage market. The broker’s spread is equal to the loan price less 100 plus the number of points paid by the borrower.
  
  After the carry trade; “ What will the value of the loan in the secondary mortgage market be”? A large quantity of delinquencies can effect the mortgage's value on the secondary market. Also, a high delinquency rate is associated with sub-prime mortgages.
  
  The perceived wealth of the US consumer is reflected in the dollar index. A large portion of that wealth is tied up in homeowners equity.
  
  A primer on financial engineering: Remarks by Vice Chairman Roger W. Ferguson, Jr. At the Annual Conference on the Securities Industry, American Institute of Certified Public Accountants and the Financial Management Division of the Securities Industry Association, New York, New York
  November 20, 2002
  Financial Engineering and Financial Stability