No news is good news

Finally, a new blog post of mine. The last weeks have been filled with work, study, some volleyball (the preparations for the season were more than great, now let's hope our team can keep this up), and a lot of time spent on the preparations of the General Members Meeting of my volleyball club taking place in two weeks. After that: no longer Ms President of the Board for me. A short, early reflection: it has been a very good experience, but it has been a rough ride as well!

Luckily, during the past few weeks, I had some time to reflect on the economy as well.

Conclusion: nobody knows what is going on anymore! However, very few people are willing to admit this. (What makes even me so sure that nobody knows, and if that is true, I do not even know whether it really is true. Annoying.) And that makes sense. Image what would happen in Ben (Bernanke that is) would say: "Guys, I don't know whether it will help, but let's stuff another huge pile of money into the economy (or in the banks, who do not want the money anyway) and see if tomorrow or next week it can stimuate job growth, housing prices, and thereby economic confidence". Nonsense of course; this will not happen in a million years. At least, I hope it will not.

But let's assume that Ben would say this. The market's logical reaction would be to abandon the USD, and move into safe assets such as gold. The gold price will rocket, perhaps with prices of other safe assets (a more difficult question is which assets will be safe in such an event, perhaps there will not even be one considered safe). The US will face a currency crisis. Banks with substantial assets priced in USD will fail, and this will lead to contagion of other banks, with soon enough really negative consequences for the real economy. In other words: economic disaster.

However, the big question is: why is this scenario so different from what is happening today? As the Fed announced nothing new yesterday; its outlook has not changed and they are still waiting to see in what direction the US economy is heading before they decide whether or not to renew their quantitative easing efforts. Hence, no news.

The same goes for the US housing market. Figures were released on homebuilders' confidence, which remained at the same level as previous month - albeit weakest level in more than a year-. Hence, no news.

Still, market sentiment was positive today. No news is good news? At least the Fed did not announce that the overall economy was getting worse and QEII was required, and also the housing market did not become worse. And this is supposedly good news.

Right.

In some other column, I wrote that this is can be called a bias in human nature. We have seen so much bad news, and perhaps even become immune to bad news. Although bad (or mixed) signals are abound, they are not breaking news anymore. And therefore, it is easy to get optimistic when some good signals show up, which is also what everyone is hoping for.
We even perceive the not-all-too-bad news as good news nowadays. Perhaps not surprisingly, but does it really make sense? The economy is still very unstable.

Market psychology is interesting. Maybe more on this next time.

FAQs part II

In my last blog I posed some questions for which we still don’t have a (more) definitive answer, except perhaps for the first question. With the Fed taking steps to quantitative easing 2.0 (albeit baby steps, since for now it has announced only to maintain the size of its balance sheet, and not let is shrink – indicated by the FOMC’s public statement last Tuesday), the markets are certainly not responding enthusiastic. More accurately: the past week has been a very hectic week for the financial markets. Worries about the recovery in the U.S. spread to more concerns about mainly the periphery of Europe. German export-led growth for now pulls the Eurozone ahead, but how long will that last? Quarterly growth was well above expected, but if countries importing German goods see their economies weaken, German growth will be unable to sustain itself. The ECB has indicated it will slowly move to exit strategies. Although problems in the periphery are still very concerning and dependence of banks in Portugal, Spain and Greece on ECB financing is increasing steadily.

The Fed, on the other hand, is much more willing to support the economy with an even looser monetary policy. Analysts and commentators alike are very pessimistic about the effectiveness of further quantitative easing. If it has not worked in the past, why would it work next time? Is there so much more the Fed can do? Well, actually, yes. But that is just in theory. Central banks worldwide are constrained by the whims of the market. Should a sudden worry for hyperinflation pop up, better beware! If central bankers do not respond quickly taking the money out of the system within a week or so, double-digit inflation may be the result.

But for now, the Fed is walking a very thin line between high inflation and deflation. Core inflation in the U.S. (excluding food and energy prices) is already in negative territory and should economic activity not pick up, negative annual core inflation is not unlikely. Of course, for a large part this is driven by the still declining housing prices. Nevertheless, deflation is a dangerous phenomenon and Ben Bernanke will do everything in its power to prevent it, but he has not indicated directly what he will do should the economy get even worse. If such measures are taken (the measures the Fed could possibly take are in an earlier blog of mine), however, the market will interpret this as a sign that the economy is doing really, really, really, really terrible. No need to explain here what that means. But on the other hand, when signs of the economy weaken, and the Fed does not respond, the markets will also react negatively.

My overall conclusion therefore is: whatever monetary policy does, it will not improve the matter much (the matter being the U.S. economy), and it is fiscal policy that should get things going again. But please not in the way fiscal policy has been used in previous U.S. fiscal stimulus packages. Let’s look at China; they really set a good example.

More on that later.

FAQs part 1

Dear blog,

(I never had a diary, so I never could write "dear diary", but "dear blog" makes up for this loss.)

With annoying music on (why do I even have 'Air' in my iTunes library?), the clock indicating its 6.37, and the 'C' on my keyboard hardly working, why not write a little blog before I go off to Utrecht?

I have to say, I missed writing for my blog. But the past two weeks were so hectic. however, it means there's room for improvement!

What's been on my mind the past week?

- Fiscal or monetary stimulus? With the Fed hinting at further quantitative easing and trying everything in their power to get the money into the economy, the markets are not reacting too enthusiastic. Will an ever looser monetary policy get the U.S. economy going? I think not. What would help is to get the money velocity up, and this is not something the Fed could do. Giving consumers extra cash they don't want does not make them spend it right?

- Ok this sounds too simplistic, I admit. But it does come down to get the consumer spending in order for the U.S. economy to get in an upward spiral again.

- So: will tax cuts for the rich U.S. citizens have to be extended? Will it do any good (i.e. get spending up)? Maybe, maybe not. Why it could get spending up (or at least not get it down once the cuts expire): the rich are the most productive. If you get them to work, this will be very beneficial for productiveness. Lowering their marginal taxes gives them more incentive to work. Why it cannot get spending up: the rich will spend as much as they like anyhow. Even if they do not have the money to spend, they will borrow, because they believe they will have the money in the future (according to the 'lifetime spending hypothesis'). The poor, on the other hand, are credit constraint as they have no access to loans and they have also no high incomes. So: giving them more money could do a better job stimulating spending. That is, given that the poor do not foresee an even worse future and therefore safe their newly acquired credit to save. Which hypothesis is the most likely? My guess is the latter, but circumstances matter. And this is where Obama comes in...

Then the most important question: will we have a double dip?

So many are writing on this topic. I'll be joining the debate soon!

Now brush my teeth and off to Utrecht for another day as an intern.

Byebye