FINANCIAL ICEBERG

Always consider hidden risks

​

CHARTS

FED Low Inflation Panic Button : Soon DEFCON 2 !

( From Financial Sense, FRED, Market Watch, Calculated Risks, CATO Institute, Federal Reserve Board )​

If you would like to receive our free daily markets updates, please Sign-up

The Situation



​​Of course, we must take care lest confidence become over-confidence. Deflationary episodes are rare, and generalization about them is difficult. Indeed, a recent Federal Reserve study of the Japanese experience concluded that the deflation there was almost entirely unexpected , by both foreign and Japanese observers alike.



​Remarks by Governor Ben S. Bernanke

Before the National Economists Club, Washington, D.C.

November 21, 2002

​

Deflation: Making Sure "It" Doesn't Happen Here









​ ​​Of course, we must take care lest confidence become over-confidence. Deflationary episodes are rare, and generalization about them is difficult. Indeed,, by both foreign and Japanese observers alike.​Remarks by Governor Ben S. BernankeBefore the National Economists Club, Washington, D.C.November 21, 2002

Japan s Coup de Jarnac

​

WE IMPORT DEFLATION ( in a falling​ product price sense ). When money leaves our nation, passes through Asian factories, then returns, it is transformed from excess demand in the form of money to excess supply in the form of products. Inflation eventually pressures demand or pressures supply.



​​Over-investment such as is in progress in China and yields excess output and lower prices. So in a sense, China s put a lot of pressure to Japans industrial base.



But now, with the rising value of the Yuan and the tumbling value of the Yen, a huge shift in pricing power already occur...From a disinflation China s to defationary Japan s.​​



​​As you can see on the graph below, each time we saw a huge shift in the Yen within a year, the impact has been direct to US import prices from Japan. Already Import Prices were falling before the Yen debacle... Deflation will be knocking at our doors sooner than later.

Dollar Yen ( Inverted / Blue / Left scale )

US Import Prices from Japan Year-Over-Year ( Red / Right scale )​

St. Louis Federal Reserve President James Bullard sees inflation as a potential problem, but not in the way you might think.



Federal Reserve Bank of St. Louis President James Bullard said Wednesday inflationary pressures may be growing too weakly and if they soften further, the central bank may have to boost its asset buying to bring price pressures back up to more desirable levels.



“Inflation is running very low” as measured by the personal consumption expenditures price index, the Fed’s favored inflation gauge, the policymaker said. “I’m getting concerned about that,” he said.



“If inflation [gains] continues to go down, I’d be willing to increase the pace of purchases” of bonds the Fed is now engaged in, Mr. Bullard said. “This is not what I expected, and I think inflation should be closer to the target than it is,” the official said, adding he considers it just as important to defend the Fed’s 2% inflation target from the low side, as it is to keep prices from going over 2%.



​

From the most recent FOMC statement:



The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.



The phrase "in the context of price stability" should cut both ways. The Fed might need to tighten policy even if the labor market is not improving if inflationary pressures start to emerge. But at the same time, it should also mean that the Fed may need to increase the pace of asset purchases even if the labor market is improving. That seems to be the current situation, yet we hear alot of Fedspeak suggesting a widespread inclination to end asset purchases this year regarless of the recent bout of disinflation.



That said, inflation might be set to tick up in the months ahead. From MIT's Billion Prices Project:

Not a worrisome move, but enough to suggest that Bullard's low inflation concern might be short-lived.



Bottom Line: Bullard reminds us the exit from the asset purchase program should not be simply a function of labor markets, but also a function of inflation. And the current path of inflation does not indicate that policymakers should be rushing ahead with a plan to end QE this year.



Fed's Kocherlakota:

​

Financial market conditions requiring the Federal Reserve to keep rates unusually low may persist for the next five to 10 years, said Narayana Kocherlakota, the president of the Minneapolis Fed Bank on Thursday. This low-rate environment, and Fed policy, in turn, can be expected to "be associated with financial market phenomena that are seen as signifying instability," such as inflated asset prices, high asset return volatility and heightened merger activity, Kocherlakota said, in a speech at the Levy Economics Institute of Bard College.



​​This instability is best addressed through effective supervision and regulation, Kocherlakota said. However, the Fed may have to confront the dilemma of whether to raise rates to reduce the risks of a financial crisis with the certainty that any tightening would lead to lower employment and prices, he said. The Fed is in a better position to address this challenge than it was in 2007, he said.



​​

​

Military history is written by the victors. Economic history is written, to a large extent, by central bankers. In both cases you have to take official accounts with a large dose of salt.

Real imports of goods and services

vs​

​ Real Gross Domestic Product

%​

Consumer Price Index for All Urban Consumers: All Items YOY ( Blue )

​ Import Price Index: China YOY ( Red )

​ Import Price Index: Canada YOY ( Dark Green )

​ Import Price Index: Japan YOY ( Green Flash )

​Import Price Index: Germany YOY ( Purple )

​

DEFCON 2 Soon on Deflation

​

​A defense readiness condition (DEFCON) is an alert posture used by the United States Armed Forces. The DEFCON system was developed by the Joint Chiefs of Staff and unified and specified combatant commands. It prescribes five graduated levels of readiness

​(or states of alert) for the U.S. military, and increase in severity from DEFCON 5 (least severe) to DEFCON 1 (most severe) to match varying military situations.

​

Some History - Episode of 2001 / 2002

​Meeting of the Federal Open Market Committee on November 6, 2002



​​MR. BERNANKE. Thank you, Mr. Chairman. I’d like to focus on a simple arithmetic implication of the unusual productivity growth that we’ve been observing, which is that it creates a wedge between the rate of output growth and the rate of input growth. As a result, we have a situation currently in which the recovery, measured in terms of output growth and spending growth, seems if not robust at least acceptable. But if we look at the economy from the input growth side or the factor utilization side, we see a very, very weak economy.



​​Indicators of labor utilization, for example, including payroll employment, the workweek, and production worker hours, have been basically flat for the year. Indeed, I had a comparison done between these series for the current period and the 1991-92 jobless recovery, and they seem to be identical.



​​Capital is likewise not being used to its capacity. Capacity utilization has not only been flat for the past year, but its absolute level is at near-record lows in the aggregate as well as in many individual industries. In short, the evidence from the input side of the economy suggests that the gap between output and potential output is, if anything, widening rather than diminishing. Continued slowing in core inflation, both at the producer and consumer levels— which I talked about at the last meeting—is consistent with the presumption of a significant output gap in the current economy.

​

I think there’s agreement around the table that in the language of macro textbooks the economy is facing a series of IS shocks—various factors that have inhibited the desire of firms to invest and consumers to buy. The right response to that normally is to stimulate and lower

​interest rates still further. The FOMC has been quite patient. We’ve kept the funds rate unchanged now for almost a year. So I think it is time to consider taking some action. A significant rate cut at this point would not be a panacea obviously, but I do think it would help.



​​MR. KOHN. Thank you, Mr. Chairman. I support both parts of your recommendation. As for the 50 basis point cut, I think we need it. Recent data are sufficiently worrisome and the most likely forecast is sufficiently tepid to justify 50 basis points. And I do think it would feed

through to long-term interest rates. Looking at Vincent’s chart of the upward-sloping expected federal funds rates, if the markets see us moving a little more aggressively, I think that could flatten that chart out a little, and the effect would feed through to longer-term interest rates. And for the reasons that Governors Gramlich and Bernanke noted, I think that would help the economy.

​

​I was particularly taken, Mr. Chairman, by your description of the costs of missing on either side. With a sizable output gap and low inflation and inflation expectations, the odds on easing so much now that we produce inflation down the road seem very, very small. But if

weakness persists or if the economy is subject to a downside shock, the costs of moving too timidly at this stage could be considerable.

​

​​On the balance of risks, this is a tough call in large measure because, whatever we do, sluggish growth and declining inflation are the most likely outcome for a few quarters. But in my mind the more aggressive action does buy a degree of assurance about more-satisfactory outcomes over the slightly longer term . And from that perspective, however murky it may be, the risks may well be about balanced. Moreover, I am concerned that retaining the unbalanced ​risk assessment along with a 50 basis point reduction in rates could leave the impression that the Federal Reserve sees the economic situation as more serious than I believe it probably is and that we’re willing to cut rates further than I believe we should with the information now in hand.

​

Situation Now from FED Ground Zero



​​

US Inflation Rate Trend



The US is one of the most open Economy​​ in the world. It does import a lot of goods and services from abroad, a little more than 16% of its total Gross Domestic Product as shown bu the chart below.

It then become sensitive to competition and change in price from abroad as shown by the graph below. The most important countries where the US do import mainly their goods are shown in the graph below in terms of import prices ( year-over-year % ).

As we may observe, The import prices are already declining since 2011 and will continue to bring downward pressure on the US CPI.

And recently, the change at the Bank of Japan brang a brand new perspective to US inflation as explain below...​