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Charts and thoughts



There's nothing particularly noteworthy in the economic news today, so what follows is a quick recap of major releases, with some observations along the way.


October Industrial and Manufacturing Production came in stronger than expected, but the bigger picture is that industrial output is rising at a moderate 4% rate: nothing to get excited about, but nothing to worry about either.




A survey of home builders' sentiment ticked up—surprisingly—this month, and this adds some weight to the case that we have seen the worst in the housing market and may be on the cusp of some improvement. The second chart, showing an index of homebuilders' stocks, also suggests we have seen the worse and are seeing some gradual improvement on the margin. Painfully slow, to be sure, but the trend appears to be heading up. The home vacancy rate also suggests that we have seen the worst and things are improving, although of course there needs to be a whole lot of improvement before we can get back to "normal" conditions. Even though we are still a long way from seeing what might be termed "strength" in the housing market, simply ruling out further weakness is nevertheless quite comforting. As excess housing inventories are worked off and the economy continues to grow and as household formations continue to exceed new construction starts, the case for a rebound in residential construction and a rebound in prices gets stronger.


As was the case with yesterday's PPI release, October consumer price inflation showed some moderation. On a year-over-year basis, there is nothing alarming going on here. However, declining energy prices have played a big role in moderating overall inflation in recent months, and that is almost surely going to reverse in coming months, since crude oil has now broken above $100/bbl. (up almost 35% from the early October low).


This chart compares the yields on 30-yr Treasuries to core inflation. In an ideal world, bond yields would be at least 2 percentage points higher than inflation, and this chart is set up to show that is the case when the two lines are on top of each other. Reality rarely matches the ideal, of course, but the chart is nevertheless helpful in gauging the valuation of bonds on a real return basis. On that score, in the past several decades, bonds have only been less unattractive at the end of 2008 (not to mention several times back in the rising-inflation 1970s). And considering that core inflation has been trending up while bond yields have declined to very low levels, the real-yield-valuation case for owning long Treasuries is very weak. Long bonds are only attractive as an antidote to fear: fear of an implosion in European financial markets that will rock the global economy and deliver us into years of recession or even a global depression. You have to be extremely worried about the future to want to own long Treasuries these days.


This chart compares the year over year growth rate of the consumer and producer price inflation. Both are trending higher, and the PPI seems to be leading the CPI in recent years, suggesting that the rise in the core CPI is likely to continue.


I add this chart to show some long-term perspective on core inflation. Note the extremely low levels of inflation in the early 1960s, when monetary policy was constrained by the gold standard, the dollar was the king of the hill, and the economy enjoyed very strong growth. Note also how this measure of inflation has crept higher since 2002-3, which was when the Fed first started to ease aggressively and the dollar began to decline. I don't think it's a coincidence that growth has been very disappointing in the past four years. With a weak dollar and very low real interest rates, speculative activity becomes more appealing than investing in the real economy. Business investment is rising, but it is lagging woefully behind the growth in corporate profits.

If there is a theme that ties this altogether it is one of growth inhibited by fear and uncertainty. The economy is growing, but only moderately. The value of the dollar is up in the air. The risks of a Eurozone implosion are palpable. Bloated government spending has suffocated economies everywhere, making debt burdens intolerable. Fiscal policies need to change radically, but the political will to do so seems lacking, and crony capitalism is on vulgar display too often. Accommodative monetary policy—which seeks to encourage more borrowing—is not a good solution to a situation made bad by an excess of borrowing, and it only weakens confidence in the future value of currencies. Gold at $1800; wild gyrations in oil prices; high-frequency trading; widening spreads on Italian and French bonds—all are symptomatic of a market that believes that there is more profit to be made in speculation than in new business investment. Speculation is what you get when you weaken the incentives to invest in productive activities for the long haul.

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