China

China sports the second largest economy in the world and its hyper-stimulated growth over the last decade has boosted growth in the rest of the world, including the US. Right now, however, the Chinese economy is foundering. Its struggle to stamp out Covid continues, with two major cities, Shenzen and Chengdu entirely or mostly in lockdown. Chinese investors have chosen to speculate in residential housing rather than the stock market, leading to a giant property market bubble with hundreds of thousands of empty or unfinished apartments overhanging the market. August sales of new units were down 33% y-o-y. Both drought and flooding have plagued the country this summer, leading to the same difficulties with agriculture and transport seen in Europe.

The Chinese government has responded with yet more stimulus, widely seen as inadequate given the magnitude of the economic problems. These problems will have a negative effect on the rest of the world.

That’ll Buff Out

Well I got that one wrong, fortunately my trading system had no dog in the hunt. Yes, Powell did hint at slowing rate increases. But the markets were shocked, shocked I say, by his acknowledgement of the 15 years of futile attempts to curb inflation before Volcker took matters in hand. That an economist should consider history rather than models and calculus is pretty much unprecedented, at least in modern times. His academic credentials may be called into question. The calculus thing was introduced because economists – it was called, correctly, “political economy” at the time – felt they were underpaid, relative to the physical sciences, and therefore needed to emulate them. It helped their prestige but not their forecasts.

Sarcasm aside, it’s a good thing. But the bad thing is there is way too much money in circulation. Consider the following mantra from Milton Friedman in 1963, years before the 1970s inflation.

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Then please consider the following:

That’s going to take a lot of buffing. And yes, Mr Powell, it is the product of years of central bank economic idiocy and arrogance. First chart St. Louis Fed, second John Hussman.

Inflation Projection

John  Hussman posted an inflation estimate on his Twitter account.

Friday

Friday is the Jackson Hole retreat, where the US taxpayer hosts a gathering of the people who believe they are the masters of the world economies.

Our esteemed Fed Chair, Jerome Powell, is expected to speak about, inter alia, Fed policy. Much digital ink is being spent on speculation about what he will say. So I will join in and spend a little.

It is important to remember that he, and many other attendees, claim to be economists. They are a dangerous species, especially when they attempt to manipulate economies and markets, as the records of booms and busts show.

Chair Powell has stated that he intends to curb inflation by slowing growth, not by slowing the economy, as in the R-word. In my personal opinion, as they say in Japan, we are going to have a deep and dark recession regardless of what Chair Powell says or does. But back to Friday. This means that he will at least hint at slowing rate increases. Of course this is not a “pivot”, more like a “swivel”. But it will be friendly to the stock and bond markets, at least for a little while.

Pivot – To What?

It seems as if every financial writer has no more important subject to opine upon than the exact date of the Fed “pivot,” when the Fed will be “forced to” resume supporting wild speculation.

Such opinions may be successful clickbait, but any such pivot is economically meaningless. Just look at the last employment report. The number of jobs increased significantly, but the number of employed persons hardly moved. People are taking on more jobs in order to, as President Bush put it, “put food on their family.” This can only go so far, for obvious reasons, and it means there are insurmountable limits on the economy’s ability to grow. Production equals labor hours times productivity. Productivity is slow and hard to improve, so not any help. Labor hours are pretty close to the wall, as shown by the average workweek which has flatlined at 34.6 (FRED). This all means that the economy cannot grow in response to stimulus. Easy money and/or a return to QE will simply result in more inflation, which will do as much or more damage to the economy and corporate profitability than higher interest rates. I cannot believe that the Fed is unaware of this reality. There is no free lunch. Pain is coming, regardless of what the Fed may or may not do. Look back at the Great Depression when the Fed thrashed around, trying everything because nothing “worked.”

Just One Chart

When you buy shares in a company, you are really buying a share of the stream of profits yet to come. This chart from John Hussman shows what is going to happen as labor reclaims its share of company income.

The extra profits in the early 2000s were financed by the housing bubble, while the recent spike is mostly the result of massive government deficit spending on subsidies and handouts of various kinds. These are coming to an end despite the best efforts of the Dems to blow up inflation.

What Will They Do?

While we sit and wait to see what the inscrutable Xi will do in response to Nancy’s provocation, we might as well speculate about what Powell – i.e. the Fed – will do in the coming month. I can think of no better basis than this – The Eye Of The Storm.

 

Rate Shock

The median price of a new home has fallen by -11.9% over the last 2-month period,

Thanks to Liz Ann Sonders.

Things Can’t Get Any Worse

The title summarizes the line being put out by Wall Street and amplified by the financial press. The logic is that it is then time to buy stocks. And it is working, stock indexes are rallying strongly as retail inflows into mutual funds and individual stocks have resumed. In turn, hedge funds and CTAs must follow, to say nothing of the resumption of buybacks as earnings season comes to an end.

Of course, things can and will get worse. The impact of input costs and other supply constraints such as war, drought and ill-advised climate change politics have hardly been felt yet in retail prices, even though they have risen substantially. Energy prices continue to be driven higher by the same bad science and emotional political campaigning. Then of course there is the labor shortage, caused by more bad government decisions partly around the pandemic, but mostly about socialist “progressive” politics.

The excess demand for labor demonstrated by the chart above means that the economy will have to slow considerably before pressure on labor costs is eased. But while rising labor costs impact inflation, they don’t mean that personal income is keeping up with inflation as food and energy prices accelerate away.

All of the above mean that the current recession will have a long way to go before inflation is reduced. Once the genie is out of the bottle, she doesn’t go back in willingly, as Paul Volcker’s efforts to contain her in the 1980s show.

Supposedly the Fed will “pivot” back to easy money (well, even easier, money is still easy with deeply negative real rates) as soon as this third quarter. Well, maybe it will – the Fed’s politically driven monetization of government debt is what has brought us here, after all. But that will bring about true hyperinflation and I doubt that Powell wants to go down in history as the Fed chairman who put politics before sound economics to complete his ruination of the world economy. I say the world economy because central bankers move in unison to avoid individual criticism.

Labor chart thanks to zero hedge, Personal Income chart thanks to Donald Swain, CFI CPA.

Kumquat?

From ECRI’s Lakshman Achuthan:

WH saying no recession & Sec Yellen saying it’s a “transition” reminds us of Carter admin economist Alfred Kahn who, when forbidden to mention “recession,” used the word “banana” instead. Banana growers protested, so he switched to “kumquat.” What’s the fruit for recession today?