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Monetary policy update and overall outlook summary


The point of this chart is to put into proper perspective the Fed's efforts to inject dollar liquidity into the global economy. It uses a semi-log scale because the change in the amount of bank reserves has been extremely large in the past two years or so. The first stage of Quantitative Easing saw bank reserves soar from about $100 billion to almost $1.3 trillion, and the Fed accomplished this by purchasing MBS and Treasury securities by the bushel, in addition to extending credit to the financial system through swaps, repos and special loans. As the latter injections began unwind, bank reserves shrunk from a high of $1.28 billion in Feb. '10, to $1.07 trillion in Oct. '10. Concerned that they might inadvertently be allowing a tightening of monetary policy at a time when deflation concerns were (allegedly) meaningful and the economy was (allegedly) still struggling, the Fed launched QE2 in Nov. '10. Those purchases have now pushed reserves up to a new high of $1.42 trillion.

Since Oct. '10, bank reserves have increased by $350 billion as a direct result of the Fed's purchases of Treasury securities. But since there has been no unusual growth in the other components of the money supply (e.g., currency and M2), and no huge increase in required reserves (reserves that need to be held against bank deposits) we can conclude that almost all of the increase in bank reserves has served merely to satisfy the economy's and the financial system's demand for bank reserves. And as I've explained before, since bank reserves are essentially obligations of the U.S. government and pay an interest rate similar to that of T-bills, which are considered to be the safest way to hold money in the world, the world was apparently eager to increase its holdings of safe money by $350 billion in recent months, and the Fed was happy to oblige.

If the world (and the banks) had been unwilling to accumulate additional stores of safe money that yields almost nothing, then we would have seen a significant increase in required reserves, a corresponding decrease in excess reserves, and a big increase in the growth of money (currency and M2). Instead of holding excess reserves in growing quantities, banks would have been putting those reserves to work by using them to generate new loans, increased deposits, and more currency. Loans would have generated a yield significantly higher than the yield on bank reserves—a virtual money-making machine. But this is not happening, because banks are satisfied with holding onto more safe, low-yielding cash, and the world in aggregate is apparently unwilling to increase its leverage. M2 is growing at close to a 6% annualized rate, and this is the rate of growth that has prevailed for the past 15 years on average, as the next chart shows. Currency in circulation is up about 7% in the past year, and has only risen at a 5.4% annualized rate in the past two years; again, no sign of any unusual expansion.


In short, the Fed has dumped a ton of reserves into the banking system, but banks have been either unwilling to make new loans, or the economy has no desire to take on more debt, or both. There is still a great deal of uncertainty out there that would explain why reserves have been hoarded instead of utilized: e.g., huge fiscal deficits that raise the specter of huge increases in future tax and regulator burdens, and of course the Fed's own potentially inflationary monetary policy.

The result of all this is that to date the Fed's actions have not been overtly inflationary (i.e., there is no sign that the amount of money in the economy has increased by enough to provoke a significant rise in inflation). However, there are several sensitive and leading indicators that suggest the Fed is in fact making an inflationary mistake: e.g., rising gold and commodity prices, the very weak dollar, and the very steep yield curve. At the same time, there have been numerous signs in the data in the past few months that strongly suggest the economy is picking up speed: e.g., the ISM surveys, rising commodity prices, manufacturing production, car sales, and the decline in unemployment claims. In addition, measures of confidence are starting to perk up, and C&I Loans are picking up, which further suggests that the economy's demand for money is beginning to decline (which would allow 6% money growth to fuel much higher growth in nominal GDP). The biggest positive on the horizon is the likelihood that Congress will finally begin to tackle our out-of-control fiscal policy trainwreck-in-the-making without raising taxes.

I think there is enough smoke out there to be worried about an inflationary fire, but I don't yet see a reason to call for a calamity in the making, as some are (e.g., a dollar collapse, hyperinflation, and another recession/depression). I do think that the risk of deflation is now virtually nil, and that therefore Treasury yields are exceptionally low and at risk of rising significantly. Measures of credit risk are still priced to higher-than-normal default risk, which is unlikely to prevail if money is indeed easy and the price level is set to rise meaningfully. Equity markets are priced with a good deal of fear built in (the Vix is still substantially above its long-term average), PE ratios are about average despite NIPA earnings being at record highs, and earnings yields are higher than corporate bond yields. So I think it still pays to be bullish on the economy, the equity markets, and corporate bonds, but bearish on Treasuries and cash.

Federal budget update


The good news about the Federal budget data recently released for February is that the deficit continues to shrink (albeit modestly) relative to the size of the economy, and the growth of revenues—which has been about 10% per year for the past year or so—continues to outpace the growth of spending, which is rising about half as fast. This is as it should be in the early years of a recovery.

The bad news is that the deficit is still huge, at $1.3 trillion in the past 12 months, and represents about 9% of GDP. That's big and bad by any standard. Keynesians have preached for years that big deficits like this are stimulative, but we have now proven beyond a shadow of a doubt that big deficits that are driven by lots of spending and transfer payments act only to slow the economy's growth. That's because they consume a significant portion of the economy's resources in a very inefficient manner. In short, they reduce the economy's overall productivity, and that results in a slowdown in the rise of living standards.


A real tango show


Last night we went to a dinner and tango show at Esquina Carlos Gardel in Buenos Aires. I've seen lots of tango—and even learned it some years ago—and this is fourth tango show I have seen in Buenos Aires. This one was clearly the best. Best, because it is faithful to the real tango, the dancers are marvelous, and the music (according to my wife) was thrilling. If you like the sort of dancing on "Dancing with the Stars," then don't see this show, because it goes to the heart of what tango really is, rather than dramatic and unrealistic choreography. Tango is an art form, and the most sensual of all dances by far.

On top of that, the theater is beautiful, the show is really well done, and it's located in the Abasto district where Gardel first turned tango into a global sensation. The show was preceded by a fascinating movie—with subtitles—that covers the history of tango. Moreover, the food was delicious; I had a huge bife de chorizo that must have weighed over a pound, and it was cooked to perfection (which, for Argentines, is appropriately called "a punto").

Food, wine, show, and transportation from your hotel to the theater and back was only $125 per person ($500 pesos). Argentina isn't as cheap as it has been in the past, but by the standards of other major cities this was a bargain.

Philly Fed index soars


The Philadelphia Fed Business Outlook Survey came in very strong. It hasn't been this strong since the economic boom times of the early 1980s. Very difficult to ignore the mounting evidence of a strong economic recovery. This is not going to be easily derailed. Plus, the survey noted widespread evidence of rising prices. Things are picking up all over the place. How much longer is the Fed going to be able to ignore this? There is absolutely no need for short-term interest rates to be zero.

Labor market conditions continue to improve


Weekly claims for unemployment continue to decline, and at a fairly impressive pace. It is difficult to imagine that the decline in layoffs will not be followed by a pickup in the pace of new hirings, considering that just about every measure of economic activity reflects decent and continuing growth.

A good explanation of the Fukushima power plant disaster

I found this explanation by Josef Oehmen to be very thoughtful and helpful. If he is right, the world's concerns are highly inflated. More good information can be found at MIT's site.

HT: Mike Churchill

Manufacturing production continues strong


February industrial production dropped a bit, but previous months were revised upwards. This chart shows a subset of industrial production which strips out things like utilities. Here we see very strong growth—an annualized rise of 6% in the past year. This is strong, and it's significant. The death of American manufacturing has been greatly exaggerated. We still haven't recovered to new highs, but at this pace it won't take long. The problems in Japan are grievous for the Japanese, but they aren't going to derail the US economy.

C&I Loans continue to grow


I was isolated in the southern Patagonia since last Tuesday, so I can truthfully say I have not been caught up in what appears to be a global "panic attack" over the Japanese radioactivity problem. I have some time today so I am beginning to catch up on the recent statistics that I've missed. This chart further confirms the pickup in C&I Loans (bank lending to small and intermediate-sized businesses) that I have been highlighting the past month. Loans are up at a 7.8% annualized rate over the past 3 months. That's significant. Deleveraging now appears to be a thing of the past, in aggregate. Confidence is returning, and this bodes well for the future.

More great photos


You usually only see this photo of Fitz Roy on posters. But we had the incredible luck of seeing it on our departure from El Chaltén. We were picked up at the Los Cerros Hotel at 7:30, right around dawn, and as we left the town, headed east, we looked back to see this. Because the sky on the horizon was relatively clear, the rising sun had illuminated the top part of the Andes (the town is in the darkness at the lower right of the photos), but not yet the bottom part. 5 minutes later, as we continued eastward, the sun had risen further and was covered up by some clouds and this view was gone—all was in darkness. It was simply breathtaking. Of all the wondrous sights we saw in the southern Patagonia, Fitz Roy was my favorite. Not to be missed!


After a 7 1/2 hour drive from El Chaltén to Torres del Paine National Park in Chile, we found ourselves surrounded by more spectacular scenery. (More on the details of our trip and where we stayed later.) Next morning we took a bus tour of the park, and took this picture at one of the stops. The V-shaped formation at the upper right of the photo is called "Los Cuernos" (the horns). Note the color of the lake (a milky blue which results from glaciar-caused sediments).

On our last day in Torres del Paine, we did a foolish thing (as we thought so for many hours on the way up) and opted for a guided hike up to the Mirador de Las Torres. This was a 22 kilometer, round-trip hike with an elevation gain of about 2400 feet. Not for the faint of heart, but the saving grace was that we started at an altitude of only 600-700 feet. After a grueling ascent, we were treated to this view:


These are the famous "Torres," or towers, that we had first seen from our hotel in El Calafate, from a distance of about 35 miles. We could also see them from the window of our room at EcoCamp—one of the few "refugios" in the Torres del Paine park (i.e., not a typical hotel, more like a glorified camp). Problem is that it takes about 7 hours by car to get from that hotel in Calafate to the Torres del Paine park, because you are forced to follow a huge loop that extends to the east and south, then suffer the bureaucratic hassles of Argentine/Chilean customs, and then endure over two hours of a dirt road that includes a bridge so narrow that our driver had to remove his side-view mirrors before crossing. Behind the rock we are sitting on is a mini-glacial lake. The valley we are in is surrounded by towering peaks, and I think it is called Valle de Silencio, since it is completely protected from the winds. The Towers are a mecca for serious mountain climbers (which we are not).

My overall impression of the southern Patagonia is that it offers breathtaking views, spectacular scenery, unmatched beauty, and an endless variety of natural wonders and diversions. Unfortunately, it is difficult to get to, it is very time-consuming to get around, and it is not cheap; all prices are set by what an international tourist crowd can afford to pay (we saw very very few local tourists—most were from the US, Canada, Australia, England, Japan, and Western Europe). The closest airport to Torres del Paine is Puerto Natales, but that is 2 1/2 hours from the park on a mostly-dirt road. English is the lingua franca; I think I saw more signs in English than in Spanish. The people are extremely friendly, the food is good-to-great, and the opportunities for exercise are unlimited.

And in the end, we saw so many world-class views that we almost lost our capacity for wonderment.

Back to civilization

We've been in Torres del Paine the last several days and are now back to civilization—in the sense that we once again have an internet connection. I'll post some more great photos of El Chalten and Torres del Paine when I have some more time. Right now we're in El Calafate waiting to board a flight to Buenos Aires.