Later this week, the world's top central bankers together with economists of note and otherwise, will meet for the annual Economics Symposium that has been held annually at the mountain resort of Jackson Hole, with its majestic views of the Grand Teton Mountains in Wyoming, by the Federal Reserve Bank of Kansas City, since 1978. It has been dubbed Oscar night for economic policy wonks.
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Jackson Hole, Wyoming - The Federal Reserve Bank of Kansas City sponsors the annual economic symposium under the shadows of the Grand Teton Mountains |
Last year, the symposium was a tribute of superlatives to the then Chairman of the Federal Reserve, Alan Greenspan. This time, the central bankers, including the Fed Chairman Ben. S. Bernanke and European Central Bank (ECB) President Jean-Claude-Trichet, will be back in familiar garb - the hairshirt. The spectre of inflation and stagflation (falling growth and rising prices) will hang over the proceedings, for the first time in more than two decades.
While recent data in the US, has eased worries about inflation, the Federal Reserve itself does not know if its lifting of the key federal funds rate from 1% in June 2004 to 5.25%, has tamed the dragon. The current worry is that the US economy will be tipped into recession.
On Monday, Bob Doll , President and Chief Investment Officer of Merrill Lynch Investment Managers wrote:
Despite our prediction of slowing economic growth, we continue to maintain that the economy is unlikely to enter into a recession. Outside of lower consumer spending levels, the economy remains in relatively decent shape. In particular, the corporate sector remains strong, with companies showing good cash flow levels and generally healthy balance sheets (although we do continue to expect corporate earnings growth to slow). Additionally, we do not expect the economic slowdown to be particularly long-lived, but we would acknowledge that there may be some rough patches over the next few months. Report
Also on Monday, the IMF said in its monthly report that the US economy appears headed for a soft landing, but long-term fiscal sustainability remains a challenge.
Prospects for the U.S. economy in 2006 remain favorable, with the IMF staff projecting real GDP growth to ease to a more sustainable pace of about 3 percent in 2007.
This soft-landing scenario is based on expectations of solid productivity growth, robust business investment, and faster external growth. Concerns remain, however, about the downside risks from the housing market, which has weakened in 2006. A more abrupt slowdown in the housing market and higher energy prices could trigger a sharper adjustment in household consumption, undermining the expansion. Report
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| President George W. Bush announces the nomination of Ben Bernanke as Chairman of the Federal Reserve, replacing Alan Greenspan upon his retirement in January 2006. The announcement came Monday, Oct. 24, 2005, in the Oval Office. |
Some Indicators of Deflating Asset Bubbles and Caution in the Corporate World
The Financial Times reported on Monday that companies and institutional investors around the globe are holding record amounts of cash – an indication that they are growing more pessimistic over the outlook for future economic and profits growth.
According to the latest data from Thomson Financial, the cash on the balance sheets of the world’s largest 100 companies has now reached $1,100bn and shows little sign of falling.
Cash holdings have been rising steadily since 1999, first breaking the $1,000bn mark in 2004 and they have remained unusually high since then.
Institutional investors are also holding on to more cash, according to recent surveys.
Last week Merrill Lynch said that a net 33 per cent of asset allocators were overweight in cash – an all-time high. “You have to go back to the Iraq invasion of March 2003 to see levels of risk appetite this low,” said David Bowers, an independent consultant to Merrill Lynch.
In Australia, plummeting property prices have meant many are confronting negative equity, where they owe more on the property than it is worth, according to Monday's Sydney Morning Herald.
The monthly UK Rightmove survey, published on Monday, shows average asking prices for UK property fell 1.6% in August, the biggest fall since November 2004.
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The UK, the monthly Rightmove survey shows average asking prices for homes fell by 1,6%, their largest decline since November 2004.
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The decline follows a jump in July when average asking prices surged 2.9%, their largest monthly rise in nearly five years.
Eurozone and forecast of inflation rising to 2.7% in early 2007
Last week, Danish bank Danske, in a report said that the ECB may be persuaded by inflationary pressures to take its policy rate directly to 4% - not 3.5% as Danske currently expects:
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If the oil price continues to rise at the same pace as over the previous couple of years, that rise will take average headline inflation in Euroland up to 3% next year, even if second round effects in core inflation will only build slowly. In fact, even if energy prices remain stable at the current level, a rise in headline inflation to around 2.7% is on the cards by Q1 next year.
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This owes partly to the fact that the planned German VAT hike will boost inflation by around 0.4%- points next year. But it also owes to the fact that the lagged effects from the historical rise in the oil price upon energy prices in Euroland are larger than many envisage. Finally, it also owes to moderate second round effects in core inflation. Hence we adjust upward our forecast for inflation next year from 2.3% to 2.5% (ECB staff 2.2%, consensus 2.2%).
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Given our 2007 forecasts of modest growth but high inflation, we expect the ECB to be in a huge dilemma around New Year. While business confidence may signal growth below trend, headline inflation will be begging for further rate rises.
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Instead of focusing on a fall in inflation the next couple of months, which is unlikely to halt the ECB in itself, markets should prepare for an upward revision from the ECB staff to inflation to be published at the meeting 31 August.
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European Central Bank President Jean-Claude Trichet |
In Monday's Financial Times, columnist Wolfgang Munchau writes in relation to the Eurozone: "that the present recovery is soft by historic standards. It only feels strong because it was preceded by several years of stagnation. The recovery cycles have become progressively shallower. Confidence surveys and leading indicators are signalling a downturn for the rest of the year and 2007. In other words, this is as good as it gets. If you blinked, you missed it.
In the past, most forecasters tended to be too optimistic on inflation...I would therefore not dismiss this above-consensus prediction. The market expects the ECB to raise interest rates by another 0.5 percentage points to 3.5 per cent this year and by a further quarter point sometime in 2007. If the Danske Bank forecast proves even remotely right, interest rates will probably have to go up by more than this."
The "Sacrifice Ratio"
It is reported that at Jackson Hole, the central bankers including Fed Chairman Ben S. Bernanke and ECB President Jean-Claude Trichet, will hear from research paper presentations and panel discussions that the cost of fighting inflation in terms of lost jobs and growth -- what economists call the ``sacrifice ratio'' -- is higher than it's ever been, and rising worldwide.
The sacrifice ratio measures how much unemployment has to increase to bring inflation down by 1 percentage point. In the US, the ratio has risen to 4 percent from 2 to 3 percent during the mid-1980s, according to Fed economists.
With prices increasingly influenced by factors, such as Developing Countries' labour costs and raw-materials demand, that are outside the control of Developed Countries, ``central banks must administer more pain to achieve the same effect on inflation,'' says David Kotok, who manages about $850 million as chairman and chief investment officer of Cumberland Advisors Inc. in Vineland, New Jersey. ``The ECB may even have to struggle more than the Fed did.'' See David Kotok's article
The "China effect" has lowered the prices of traded goods in the past decade but rising Chinese wages and other costs, suggest that this positive impact in Developed Countries, is falling.
So more jobs would need to be lost to achieve the same decline in inflation.
Bloomberg News refers to Michael E. Feroli, an economist at JPMorgan Chase & Co. in New York, who says that up until the mid- 1990s, an increase of 1.5 percentage points in the unemployment rate was enough to bring inflation down 1 percentage point.
``Now, the same reduction in inflation would take a 4 percentage point increase in the unemployment rate,'' he wrote in a report last month.
``The advance of globalization will tend to reduce the role of domestic factors in price determination over time,'' Kim Schoenholtz, senior economics adviser with Citigroup Inc. in New York, said in another July report. ``As a result, larger policy swings eventually may be needed to secure price stability.''
While the ECB doesn't publish an estimate of the ratio in the eurozone, Bloomberg says that economists acknowledge the same trends are at work. Trichet has already raised the ECB's benchmark rate four times since early December, to 3 percent, and the euro has gained 8 percent against the dollar since the start of the year.
Even so, inflation has been above the Bank's target of just below 2 percent for 18 consecutive months, and economists are lifting their forecasts of how much further it will raise borrowing costs.
Michael E. Feroli's colleague David Mackie, at JPMorgan Chase & Co. in London, forecasts that the ECB rate will go as high as 4 percent.
