ECB Good, Federal Reserve Bad

Today the European Central Bank (ECB) announced it was raising its interest rates from 1% to 1.25%. Given that the European economy, particularly the economies of Greece, Italy, Spain, Portugal, and Ireland, are supposed to be in poor shape, that may seem like a dramatic tightening of the screws. It is not. Interest rates are still very low in Europe. Any shortage of credit, or of takers, is not due to interest rates being too high. 1.25% should provide good support to further economic expansion.

In contrast in the United States of America the Federal Reserve Board (the Fed) recently left its benchmark interest rate at zero. That is right, 0%. I admit I would like to borrow some money at 0% interest, but the Fed alone lends to its member banks. The same people who charge you 15% to 35% interest on credit cards. This unprecedented low American interest rate did not make much sense even during the Panic of 2008. 0.25% or 0.5% would have been just as supportive to the economy and the banking system.

We are now in a pretty ordinary recession, except the prices of certain commodities have spiked due to global demand and limited supplies. The Fed's public argument is that the low rates are because a lot of Americans are out of work. One thing I know, the Fed does not care about the type of Americans who are out of work, unless they are banking CEOs. They are keeping interest rates low for the benefit of the banks, of the federal government (it keeps interest on the national debt low), and for large corporations that can currently borrow vast sums of money at huge rates. In my role as analyst I have not seen much corporate borrowing used for industrial or work force expansion. It is typically used to buy back stocks or mergers.

The dangers of these unprecedented low interest rates are so clear that even a few Fed board members have pointed them out. They can lead both to inflation and to more asset bubbles. We certainly already have a gold and silver bubble. Bubbles were the problem in the first place. New bubbles do not a sound economy make.

Meanwhile, ordinary savers are suffering from low interest rates. Retired people are having to eat their principle because they are getting almost no interest from CDs and bonds. The Fed says there is no inflation, but if your main discretionary expenses are gas and food, there is a lot of inflation. Other recessions were not met with such low rates.

Since 1952 the Fed had set interest rates below 2% for only a few brief periods, before 2008. [See Federal Reserve rate history] Given that the Fed should manage for the long term (not acting like Wall Street traders who can't see beyond the current quarter), the Fed's rate should already be at 2%.

Given that (at least in free market theory) private loan rates should be set by supply and demand, that should not budge rates for housing. Anyway, low interest rates have failed to provide an incentive for people to buy homes. Homes are seen as a bad investment; people want easy money, not assets that are taxed yearly (with real estate taxes) and need to be repaired regularly.

The Fed are cowards. They don't want to tick off Wall Street or Congress (Republicans want low rates for their business friends, Democrats because they don't understand economics). 2% is very supportive of economic expansion. If we had already gotten there gradually (or were near there like the ECB is now), then further gradual adjustments could be made, up or down, depending on the genuine need for credit for economic expansion, or on the danger of inflation.

If I were the President (fat chance) I'd fire the bums on the Federal Reserve and hire some people who can actually do the job.

Data: ECB interest rate press release April 7, 2011

2010 Economic Analysis & Forecast

For once I am basically in agreement with most mainstream economists on what is ahead in 2011.

We are still in the virtuous cycle ramp that follows an economic downturn. Most of the differences between economists are about the strength of the ramp and what particular sectors will lead and lag the economy as a whole. Wild cards include possible actions by the Federal government, the Federal Reserve, and bankers in China and Europe. Double wild cards include natural catastrophes and military incidents.

Leading the trend both globally and in the United States will be manufacturing. This could be more than a bounce-back in the U.S. because it is an increasingly attractive place to do manufacturing now that wages are closer to the global norm. People forget that losing factories to China has not destroyed as many jobs in the past century as advances in information technology and automation have destroyed. I expect increased demand in the U.S. and globally for U.S. products, and the beginnings of a round of capital investment in new and expanded U.S. manufacturing facilities.

Lagging the trend will be the housing and general construction market, which in turn creates demand for wood products, metals, and etc. However, there is very, very little new housing stock in existence right now, in a nation that typically adds over 3 million people each year. Also, a lot of people are overcrowded. College and high school graduates from the past few years are dying to get a job and move away from mom & pop. Even if people who gain employment enter the housing rental market (instead of buying houses), this will make landlords happy and more willing to buy up existing housing stocks. I don't expect a price boom in 2011, but building new houses (and apartments) is going to start looking attractive in some specific markets as the year goes on. If banks gain confidence, we could get back to a normal balance between buyers and sellers by the end of the year. However, predicting timing is difficult because the decisions are driven by diverse buyers' mental states.

Bonds should fall (resulting in higher interest rates), but that is dependent on Fed action and risk assessments by bond holders. The stock market should rise because return on investment, at least in the next few years, should be a lot better than investments in bonds or real estate. In the stock market, however, it will be more important to look for companies with long-term growth prospects, rather than just growth due to bouncing back from the recession.

The national debt is going to grow by leaps and bounds because even strong economic growth won't generate enough tax revenue to cover the spendthrift ways of the Democratic Party and Republican Party. The 2011 budget is already shot and 2012 is an election year, so expect the new Congress of 2013 to contend with a tidal wave of debt.

Jobs should be more plentiful in 2011, but employers will still be able to pick the best workers and offer relatively low wages. This is good (for the economy, not for the unemployed) because low-productivity workers are a drag on businesses. Good workers help generate the profits that are needed to expand, and which eventually force companies to hire and try to train less reliable workers. The unemployment rate should drop by a percent or two, but will remain brutally high for the least employable citizens.

The Federal Reserve should have already raised interest rates to the 2% level, but I expect them to keep rates near 0% for the entire year, because they have a proven record of irresponsibility and incompetence. Or perhaps I should say they are competent at serving their fellow bankers, but not at their mission of maintaining relatively even economic growth. Why say rates should rise even with continuing high unemployment? Because any rate under 4% will support economic growth, and having to raise rates rapidly later on will lead to bad decision making or even panic.

People at every level are looking for opportunities, and 2012 will be a good year for many.

AMD, national debt, analyst conference calls update

No, there is no connection between microprocessor design company AMD and the national debt.

This is just to let you know I posted my summary of the AMD Q3 analyst conference call. AMD's profit margin was better than expected, but the real question is how their new processors will do in 2011.

Also, in my more general interest blog, I posted a very serious essay that should be of interest to investors, economists, and policy makers: Save America, Sell Alaska.

Coming up this week: Intuitive Surgical (ISRG) and Gilead Sciences (GILD) report Q3 2001 results on Tuesday after the market closes. As usual I'll be posting summaries of the analyst conference calls. For a list of the companies I cover and the dates they hold their conferences see my Openicon Analyst Conferences Covered page.

The Federal Reserve May Have a Hidden Agenda

If I had a seat on the Federal Reserve, I would have voted for a quarter-point increase in rates at the latest meeting. I believe that the low federal rates are not being passed along to consumers partly because of inflationary expectations. In other words, low rates are not helping as much as they normally would to get the economy back in growth mode because they are fueling short term inflation and long-term inflationary expectations. They are helping to prop up the idiots who run the nations major banks by allowing them to borrow at low rates and lend at high rates, but a quarter-point increase would not have cut into that game substantially.

A quarter point rise would have had an immediate positive impact on the dollar, which would have the effect of decreasing the contract price of oil, which in turn would reduce gasoline prices and give consumers some cash (or credit) to buy other items.

Gradual quarter point rises would not hurt the housing market or dampen the economy in any way. Four quarter point rises over the course of one year would only raise interest rates to 3%, which is still extremely accommodating.

The bankers who have been given seats on the Fed presumably know all this. Do they want to keep gasoline prices high? Are they willing to sacrifice the economic health of the middle class and working class to achieve an extra quarter-point differential in bank profitability? Well, yes, after all they are bankers. But I think there is another item that has been on the agenda for decades now. The Federal Reserve statements don't mention it, and neither does the financial press, at least not in the context of interest rate decisions.

Interest rates have an large long-term impact on the size of the national debt and the annual payments on that debt. This is not a new problem, but the size of the national debt has reached a magnitude that it impacts the Federal Reserve's leeway to raise rates. This is the real reason rates have been kept consistently too low for the last two decades.

The national debt as I write stands near $9.37 trillion [See debt clock]. Interest paid on it is an average over different time terms for the debt and different points where the debt was auctioned off. However, choose a nice round number like 1%. Over the course of 10 years most of the bonds representing the debt are turned over, so if my hypothesis is that the Fed is keeping rates on average 1% lower than would be ideal for their basic mission (economic expansion with minimal inflation), we are talking about saving the federal government 1% a year on debt. In round numbers, that is $94 billion a year. Over ten years, you can round up to a trillion dollars.

Now look at a truly bad scenario. What if, to fight inflation, the base rate was raised from 2% to 5%? Over ten years we are talking $3 trillion.

What should have happened during the late 1990'2 was the Fed should not have accommodated Congress, the President, and stock market speculators. The Fed is accommodating a federal budget that keeps taxes low on rich people and corporations, but spends a lot of money that mostly goes into corporate coffers. The War on Terror is great for defense contractors, but it is killing the economy. And the terrorists know it.

American Seniors pay for all this in another way. They tend to have their liquid capital in CDs. Low interest rates set by the Fed hurt senior retirement income disproportionately.

The war on terror should be handed over to the CIA and military special operations groups. Having a lot of soldiers on the ground, like we do in Iraq, is an ineffective waste of taxpayer money.

I believe we are in a situation where we can have better long term prosperity by raising interest rates modestly, cutting federal spending modestly - mainly in the Defense budget, and raising taxes modestly. But given the control of the Federal Reserve by the self-serving banking industry and the weakness of the current President and both major party Presidential candidates, I am not using that scenario to model the future.

I am modeling an ever-expanding national debt that will at some point hit a tipping point and turn the United States into a 2nd rate economic and military power. It happened to England after World War II, it happened to the USSR in the 1970s, and it is going to happen here, the only question is when.

Which, by the way, does not mean I'm pessimistic about my stock portfolio. Many individual corporations will survive this calamity, if necessary by basing themselves in countries that run their economies on a more rational basis. Owning companies that have strong intellectual property and management teams is the best economic bet Americans can make right now.