Bernanke and Unemployment

In the face of ten percent unemployment Google is giving all its employees a ten percent raise. While at first this might seem to defy logic, in fact it reflects the reality that unemployment is not spread evenly throughout the labor force.

While most of the unemployed are unskilled or low skill workers, there is a sufficient shortage of highly skilled workers that Google is forced to pay more to try to combat the recruitment of its people by other high-tech companies.

What does this have to do with The Fed? Bernanke is deliberately goosing the money supply, partly in an attempt to inflate asset values, especially stocks. This is supposed to make consumers feel richer so they will spend more, creating more demand for goods and services, hence more jobs. Also, the cheaper dollar will make US goods cheaper for other countries, thus increasing exports and, again, creating more jobs.

The problem with the first part of this strategy is that much, if not most, of our jobless rate is a direct result of the real estate crash, which shows no signs of a quick recovery in spite of historically low mortgage rates. Increasing the money supply beyond the level justified by current rates of economic growth creates inflationary expectations. This causes investors to demand higher interest rates on mortgages to offset the diminished purchasing power they will suffer on the invested capital.

It is true that it may stimulate more home-buying interest for the same reason – expectation of rising prices due to inflation. The trouble there is that most people who can afford a home already have one. Home ownership rates, now near 67%, are still 2-3 percent higher than the long-term average. Trying to increase that percentage is exactly what got us into this mess in the first place. Also, appropriately, mortgage loan qualification requirements have become much tighter – no more one-hundred percent loans with no proof of income.

As for the second strategic objective, increasing exports, this will work for a while. The danger is that we risk stealing production from other nations, causing them to drive down the value of their currencies, too. The result could be a devastating currency war and world-wide recession or worse. We are doing the same thing that we are accusing the Chinese of doing, which they are.

Further, we are risking the dollars status as the reserve currency of the world. Loss of that status would greatly reduce the world demand for dollars, likely touching off a ruinous hyper-inflation here at home.

'O' Team Hopelessly Left

I read a piece in the Sept. 13 WSJ by Obama's outgoing auto czar, Steve Rattner, about a meeting with the Obama economic team in Jan. 2009. The discussion was about the auto industry and specifically Chrysler. Emanuel interrupted with his usual abrasiveness, "Why even save GM?" Ron Bloom, Rattner's asst., responded, invoking the plight of "the tens of thousands of auto worker," who would lose their jobs. Emanuel fired back, "F___ the UAW!"

This tale is consistent with reports that Emanuel is leaving because of conflict with the ideologically driven leftist team that 'O' has surrounded himself with. Now, Emanuel is no conservative, so this tells you just how 'out there' the Obama camp is. This reinforces my belief that 'O' will not be capable of moving to the center a la Clinton after the 1994 Republican take over of Congress. Clinton didn't give a hoot about ideology: he just wanted to be popular (and get reelected). Just look at 'Os' eyes: like MLK, he "has a dream", but it's a nightmare for us.

Bond Bubble or Deflation?

With the 10 yr. U.S. Treasury bond yielding only 2.74%, there is talk of a bond bubble. Since bond prices move in the opposite direction of interest rates, bond prices have gotten rather heady. But this rate may be better than it seems and the bubble talk may be a bit premature.

In July the core (excluding food and energy – who buys that stuff?) inflation rate as measured by the Consumer Price Index (CPI) was at an annualized rate of 1.2% according to the U.S. Dept. of Labor. That would indicate that the real, inflation-adjusted yield on the 10 yr. is a puny 1.54%. But, as always, the devil is in the details, in this case, the way the CPI is computed.

Housing costs make up 40% of the core CPI, probably not unreasonable for the average family (remember, that’s after food and energy). The problem is in the way the government calculates housing costs. It uses the rental value of houses instead of a factor of price and mortgage rates, even though 67% of Americans own their homes.

Everyone knows that house prices generally have fallen significantly almost everywhere, some places as much as 50%. At the same time mortgage rates have dropped from about 6.5% to 4.5, a drop of 30%. According to an article in the August issue of Money Magazine (p. 35), since 2005 average rents have increased 11% while average home prices have dropped 30%.

The exact calculation calls for mathematical skills beyond my grasp, but, clearly, the largest component of the CPI has been rather seriously overstated, meaning that the Index is significantly overstated. Hence, we probably have slightly negative CPI, which means that real interest rates are higher than the nominal, or stated, rate.

The good news for those with cash is that you’re doing better than you thought because the purchasing power of your money is holding steady or even increasing. The bad news for the economy as a whole is that we may already be in the early stages of a deflation, a period of declining prices. When a deflationary psychology takes hold, people tend to hoard cash waiting for prices to fall further. The resulting decreased demand often leads to high unemployment and a hard-to-arrest downward economic spiral.

The Inflation Gain Tax

A friend recently was telling me about a condo he is in the process of taking back due to a default on the mtg he carried back when he sold it a few years ago. He is quite sanguine about the situation because, he said, he paid only $35,000 & can sell it now for $200,000. I asked him when he bought it & he said in 1969. So I went to an on-line inflation calculator & found out that it takes 202,000 2009 dollars to = 35,000 1969 dollars. So even if he is right about its value, in real, inflation-adjusted dollars, its worth about what he paid for it. He has had no real gain. But, the IRS will say that he has had a cap. gain of $165,000, which this year would mean a tax of $33,000, incl. US & State of CO. (I'm not going to get into depreciation recapture.)

This is not taxation, this is theft. The gov causes inflation by printing too many dollars, but does not let us adjust our cost basis in computing cap. gains taxes. The result is that we are taxed on illusory "profits." This has to qualify as a RICO (Federal racketeering) violation, don't you think?