Inflation over 8 percent?

A lot of people aren't making really big home purchases right now. What happens to inflation when really big purchases are excluded? From CBS News:

Forget the modest 3.1 percent rise in the Consumer Price Index, the government's widely used measure of inflation. Everyday prices are up some 8 percent over the past year, according to the American Institute for Economic Research.

The not-for-profit research group measures inflation without looking at the big, one-time purchases that can skew the numbers. That means they don't look at the price of houses, furniture, appliances, cars, or computers. Instead, AIER focuses on Americans' typical daily purchases, such as food, gasoline, child care, prescription drugs, phone and television service, and other household products.

The institute contends that to get a good read on inflation's "sticker shock" effect, you must look at the cost of goods that the average household buys at least once a month and factor in only the kinds of expenses that are subject to change. That, too, eliminates the cost of housing because when you finance your home with a fixed-rate mortgage, that expense remains constant until you refinance or move. . . .

The Fed's stupid attempt to shift bond yields

Let's say that you really think that the Fed can shift bond yields by selling short term bonds and buying long term ones. If you really believed that, would you announce your were going to make those changes before you did it? If you announced that you were going to sell short term debt and you drove down those prices before you sold them, you won't get that much money for what you sell. If you announced that you were going buy long term debt before you did it, that would drive up the prices of long term debt and make you have to pay more money for what ever you bought.

The real problem is that we live in a massive international capital market. As the government shifts its holdings, private parties in the US and government around the world will shift in the other direction. So the bottom line is that I don't think that the Fed can do much to change prices. If they can change prices, why would they want to announce that they are doing this in advance?

The latest move by the chairman was a decision to dramatically recast the Fed's $2.65 trillion securities portfolio in an effort to reduce long-term interest rates. The Fed plans to shift its holdings so it will have more long-term U.S. Treasury bonds and more mortgage debt than previously planned. It hopes the lower rates will boost investment and spending and provide a shot of adrenaline to the beleaguered housing sector.

The shift toward longer-term Treasury securities was largely expected but slightly bigger than many in the markets had anticipated, and the action on mortgage bonds was a surprise. . . . .

Newest Fox News piece: Don't Single Out Standard & Poor's for Being 'Political'

My newest piece starts this way:

Federal Reserve chairman Ben Bernanke couldn't deny the obvious in his speech Tuesday in Atlanta. The economy is bad, with Obama’s “recovery” is setting records for being anemic and the unemployment stuck above 9 percent. Almost 5 million Americans have completely given up looking for work and left the labor force since the "recovery" that started in June 2009.
GDP growth the seven quarters into the Obama recovery has averaged an annual rate of only 2.8 percent, a fraction of the 4.6 percent average growth during recoveries since 1970.
And this recovery would have been even worse if the Federal Reserve hasn't been pumping in trillions of newly printed dollars into the economy, with the so-called "Quantitative Easings" 1 and 2. The current round of this injection, QE2, is scheduled to end on June 30th and will end up putting in almost $900 billion ($600 billion from buying government bonds and $280 billion from buying mortgages). But the Bernanke's announcement today of a new round of printing money is bad news. . . .

Apparently making currency that is hard to counterfeit is very difficult

It took a little while to figure out this error. This is interest both in terms of how hard it is to make currency that is difficult to counterfeit. But also it shows how these mistakes in recalling the currency impose costs on American companies.

With the holiday shopping season in full swing, authorities are scrambling to do everything they can to keep U.S. cash flowing.
'There is something drastically wrong here,' one source told CNBC. 'The frustration level is off the charts.' . . .
CNBC sources claimed that printers have produced 1.1 billion of the new bills - but those bills are unusable because of a creasing problem.
The paper folds over during production - revealing a blank, unlinked portion of the bill face.
After printing, officials discovered that some of the new bills have a vertical crease that, when the sides of the bill are pulled, unfolds and reveals a blank space on the face of the bill.
At first glance, the bills appear completely printed - but they are not. . . .

My newest Fox News piece: "Playing Chicken With China, why huge increases in the money supply didn't increase inflation"

My newest Fox News piece starts this way:

The Federal Reserve has already injected hundreds of billions of new dollars into the economy since the recession started. Normally, when the government prints up more money, dollars are worth less and that is what we call inflation. But inflation has been surprisingly low.

One measure of the money supply, M1, which includes currency as well as checking accounts, soared by 26 percent between August 2008 and September this year. The amount of currency more than doubled. But prices barely changed.

As Fed Chairman Ben Bernanke goes forward with plans to print up another $880 billion, someone has to ask why the past increases didn't produce the inflation that everyone thought they would.

So where did all that new money go? Many blame businesses for hoarding cash. Obama recently said: “corporate profits are doing just fine. [But] they're holding onto a whole bunch of cash -- they're kind of sitting on it.” . . .

Data on China's Foreign Currency Reserve Holdings and how that has changed with increases in the US Money Supply

Click on the chart to enlarge.

The Chinese data are available here for 2008, 2009, and 2010. The M1 data are available here.
A 2008 China Securities Journal article reported that over time "The current dollar reserve assets ratio of the total reserve assets has long been stable at 65%..." On October 14, 2010, The Economist noted: "China holds by far the world’s biggest stockpile of foreign-exchange reserves, worth $2.6 trillion at the end of the third quarter. About 65% of these holdings are in dollars, according to the China Securities Journal, an official newspaper."

UPDATE (11/25): During the period from January 2006 to January 2008, PBoC went from $549 billion in US Dollar Foreign Reserves to $1.03 trillion, an 88 percent increase. The level of PBoC Treasury and Agencies as a percent of Chinese GDP growth appears to have experienced a much smaller percentage change increase in those holdings. Assuming that ALL the PBoC US Dollar Foreign Reserves were invested in Treasury and Agencies in January 2006, the second graph here implies that most of the increase in Dollar reserves isn't invested in Treasury and Agencies.

US Treasury Bond holdings by country are available here. Click on the figure to make it larger. Historical data are available here. I don't have the information on "Agencies" held by the PBoC, but I would guess that they are probably positively correlated with the US Treasury Bonds.


A related discussion with slightly different numbers is here. In August, China's holdings of US Treasuries was less than half of the $1.74 trillion in US Dollar Foreign Reserves held in August.

The cash-rich Chinese government reduced its US Treasury bond holdings to 843.7 billion dollars in June, the lowest level since at least the same month last year, the Treasury said in a report on international capital flows.
The June data was lower than the 867.7 billion dollars in Treasury bonds held by the Chinese in May and 900.2 billion dollars in April. . . .

It is very interesting how the gap between BPoC's US $ Reserves and the BPoC's US Treasury holdings have increased substantially over time. If this difference in holdings is made up by the BPoC holding US dollars, it could help explain some of the drop in velocity that offset the increases in the money supply.

Fed slashes growth forecasts

According to the Financial Times, the Fed seems to believe that despite its quantitative easing" growth will remain slow and unemployment high for the next couple of years.

When the FOMC published its last forecasts in June most members thought that 2011 growth would be between 3.5 and 4.2 per cent, but many now think growth will be between 3 and 3.5 per cent, and some expect less than that.
FOMC members have made particularly aggressive upward revisions to their unemployment forecasts, with a large number now predicting that it will still be 8 per cent or above at the end of 2012, compared to the 7.1 to 7.5 per cent that they forecast in June.
“Because I expect hiring to strengthen only gradually, the unemployment rate is likely to remain elevated for quite some time. In fact, I do not expect it to fall below 8 per cent before 2013,” Sandra Pianalto, president of the Cleveland Fed, said in a speech last week.
Some Fed officials have become concerned that workers have the wrong skills, or are trapped in the wrong places because they cannot sell their home, and will struggle to find jobs even once the economy fully recovers.
These officials may raise their forecasts of long-term unemployment by a full percentage point to more than 6 per cent – although the rules for forecasting mean they must disregard any rise that they think is due to the extension of unemployment benefits that will expire. . . .