Another false alarm on US inflation?

Gavyn Davies

Jul 23 06:00

Another such scare has been brewing recently. Core CPI inflation is running at 1.9% on a year ago, even after today’s reassuring data for June. James Bullard, the President of the St Louis Fed, is warning that an upside inflation surprise is feasible in the near future, if indeed it is not already happening

Although Mr Bullard describes himself as the “north pole of inflation hawks”, he has not previously been a doom monger about immediate prospects for inflation, so his views deserve to be taken seriously.

The reason for the latest scare is that several measures of US inflation had been rising markedly before today’s data. As so often in the past, this happened because of temporary spikes in commodity prices, especially oil. But these have usually been reversed before a generalised inflation process has been triggered.

In order to assess whether inflation is or is not a generalised economic process, several core measures have been developed inside the Fed. These are designed to remove spikes in commodity prices and other flexibleprices, so that more persistent, underlying inflationary pressures can be laid bare. In the latest inflation scare, several of these core measures had shown a marked increase to their highest levels since 2008, which was worrying. But on today’s data, they have fallen back:

Even before today, the leadership of the FOMC has shown no concern at all about rising inflation, and nor had the financial markets. Given the costs of being wrong about this, it is worth asking whether they are being complacent.

It now seems probable that part of the recent jump in core inflation was just a random fluctuation in the data. There have been suggestions that seasonal adjustment may have been awry in the spring.

But the main reason for the lack of concern is that wage pressures in the economy have remained stable, on virtually all the relevant measures. The Fed published the following chart in last week’s Monetary Policy Report to Congress:

Wage inflation is apparently still fixed at around 2 per cent, exactly where it has been ever since the Great Financial Crash in 2008. Productivity growth is volatile from one quarter to the next but, according to Goldman Sachs’ productivity tracker, the underlying growth rate has been running at about 1 per cent per annum in recent years. That means that the underlying growth rate in unit labour costs (labour costs less productivity growth), which is a crucial indicator for the Fed, is running at only about 1 per cent. This is consistent with price inflation at only half the Fed’s 2 per cent objective.

In a major change from their attitude in recent decades, central bankers (even the Bundesbank) have been suggesting that wage inflation is too low, not too high. In the US, wage inflation needs to accelerate to over 3 per cent before the Fed’s leadership would worry that it indicates above-target price inflation for a significant period of time. Although labour market slack is clearly declining as unemployment falls, Fed research published yesterday argued that there remains a large pool of long term unemployed and discouraged workers that can be drawn back into the labour force as the economy expands.

Can price inflation accelerate meaningfully without this being accompanied by a rise in labour cost inflation? It could do so if import prices, or profit margins, provide an inflationary impetus, but neither seems very likely at present. Profit margins are already at very high levels by the standards of past cycles, and global goods prices, excluding commodities, still seem very subdued.

Atlanta Fed President Lockhart said last week that the Fed should wait until it sees “the whites of their eyes” (meaning higher inflation) before raising rates, and Chair Yellen warned about previousfalse dawns” in the economy. There is nothing in today’s inflation data to make the doves change their minds. On today’s evidence, there has been yet another false alarm on US inflation.

Peru’s Self-Sabotage

César Gamboa

JUL 22, 2014
Peru Child

SAN MARCOSYou may know Peru as the cradle of Incan civilization. Or you may have tasted its outstanding cuisine. But Peru boasts another impressive characteristic: it is among Latin America’s fastest-growing economies, with GDP up by 4.8% year on year in the first quarter of 2014. Peru’s long-term prosperity, however, is far from certain.

In fact, Peru’s economic growth – which is based largely on exports of raw materials and hydrocarbons – is already slowing, from annual rates of 5.5-6.9% over the last three years. And, though the government recognizes the need for growth-enhancing reform, its approach is all wrong.

Specifically, President Ollanta Humala recently won legislative approval of a set of realisticprocedures to reduce the red tape perceived to be hampering investment in the extractive industries – the very industries on which the economy should become less dependent. The new law seriously weakens Peru’s ability to regulate land use, set environmental quality standards, and rein in corporate misconduct through environmental-impact assessments.

The Peruvian government now has a serious problem. Beyond diminishing Peru’s international credibility as a “climate champion” – an image that some members of the government have been attempting to cultivate – the law jeopardizes Peru’s natural environment and economic-growth prospects.

Peru’s government has not just failed to do what is needed; it has actively worked against its country’s long-term interests. At a time when countries should be regulating land use more strictly, Humala’sreformeliminates zoning restrictions.

Moreover, under the new law, subnational governments will no longer be able to limit investments on environmental groundsdecisions that were guided by strict technical standards and highly trained experts. Instead, a national authority that is, a political body – will call the shots. All of this makes Peru more vulnerable to corporate misconduct that results in environmental damage.

As if that were not enough, the new law, in a reversal of previous legislation, could lead to reduced sentences for offenders, and even allow them to operate with impunity for three years. This is good news for mining, oil, and gas companies eyeing rich reserves under the Amazon rain forest and the Pacific shelf. But, for indigenous communities, it will open a new chapter of dispossession, poverty, and strife; and, for all Peruvians, it amounts to a massive missed opportunity to put the country on a more sustainable development path.

The problem is not the government’s efforts to support businesses; measures to bolster business growth and development would be critical to any economic-reform plan. But allowing companies with poor environmental records to operate with impunity is no solution. A country where legislation is tailor-made to benefit a few, at the expense of the public interest, cannot achieve long-term inclusive prosperity – and is likely to experience social instability.

The new law is not the only problematic policy that Peru’s government has pursued. Last month, the Congress also moved to weaken the government’s environmental oversight, claiming that this would add 1.5-3% to the economy’s growth rate. The government pushed the proposal through in a little more than two weeks, with only token public consultation and no time for reasoned public debate. Given strong opposition from civil-society groups, political parties, the United Nations, and even some business interests, the government’s behavior was both understandable and inexcusable.

In fact, more than 100 organizations rejected the package before it was approved, while calling for higher environmental standards and stricter enforcement. They recognize that what Peru urgently needs is a new, future-oriented economic vision, focused on reducing its reliance on the extractive industries, whose days are numbered. “Greeninvestment – which, as the World Bank recently proved using robust economic modeling, does not constrain economic growth – is a good place to start.

In September, Humala will go to New York to outline Peru’s bold and ambitiousactions to head-off the global climate crisis. In December, Peru will host the next round of UN climate negotiations, with governments from around the world gathering in Lima to pursue a comprehensive agreement that supports a transition from environmentally devastating fossil fuels to low-carbon energy solutions.

Peru’s recent actions have severely undercut its ability to act as a global climate leader, to everyone’s detriment. Only with a new strategy based on economic diversification and investment in renewable energy can Peru achieve stable, inclusive, long-term prosperity – and make a real contribution to mitigating climate change.

César Gamboa is Executive Director of Derecho, Ambiente y Recursos Naturales (DAR), a Peruvian non-governmental organization that focuses on law, the environment, and natural resources.

July 22, 2014, 4:24 PM ET

Fed Worries About Effects of Its New Interest Rate Tool on Markets

By Michael S. Derby 

When the Federal Reserve started tests late last year of its so-called reverse repo facility, some officials hoped it would play a starring role in the campaign to raise interest rates when the time comes.

But now the Fed thinks the new tool will play no more than a “useful supporting role,” largely because of rising concerns about its potential effects on the financial system, according to the meeting minutes of the Fed’s June policy meeting and recent comments by Fed officials (who spoke before the week-long blackout period preceding their next meeting July 29-30).

More and more people are expressing reservations” about the reverse-repurchase agreement facility, said Philadelphia Fed President Charles Plosser in an interview. As the program is currently designed, “there’s a lot of things that might happen to the plumbing of the money markets, and people have gotten…concerned that there’s a lot we don’t know” about how this will all work when put to the test, he said.

Together, the minutes and officials’ remarks shed light on the Fed’s continuing internal debate over how to raise short-term interest rates from near zero, where they have been since late 2008. Officials are still weighing which tools to use and in what combination. The discussions are prompted by worries their traditional main lever for influencing borrowing costs, the federal funds rate, will be less effective than in the past.

The officials agreed at the June meeting that the fed funds rate, an overnight rate on loans between banks, “should continue to play a role” while a newer rate the Fed pays banks on the reserves they park at the bank “should play a central role,” the minutes said. And while the reverse repos would be used as well, officials did not expect them to become a permanent part of their long-run operations.

Through the reverse repos, the Fed lends Treasury bonds it owns for a day in exchange for cash from eligible banks and other financial firms, paying the participants interest on the transaction. Proponents of the tool believed this interest rate could serve as a floor for all short-term rates in the economy.

Fed officials have highlighted two main concerns about the program. First, some worry that in times of financial turmoil market participants might pull their cash out of private markets and move it to the Fed’s repo facility, creating a de facto bank run.

“The broad concern is whether we want to facilitate what could be a period of financial stress by providing in any sense an extremely large or unlimited refuge [for investors], and whether that would tend to exacerbate a financially stressful situation,” Atlanta Fed President Dennis Lockhart told reporters recently.

The second concern cited in the minutes was that the reverse repos, even in a testing phase, could make the central bank a too large presence in the markets “and reshape the financial industry in ways that were difficult to anticipate.”

A recent report from Fitch Ratings said the Fed had become the largest single provider of borrowable Treasury bonds in the broader repo market, where banks go to borrow and lend bonds and invest cash on a very short-term basis.

Fitch observed the Fed was displacing private financial firms that had been lending Treasury bonds. That alarms officials who would rather to see a reduced central bank role in private markets after years of aggressive post-crisis interventions.

Fed officials at the June meeting discussed ways to design the repo program to address the concerns, such as by limiting its usage overall or the parties eligible to participate, the minutes said.

St. Louis Fed President James Bullard told reporters last week that however the Fed wishes to characterize it, the reverse repo facility would still be setting the floor or baseline short-term interest rate in the U.S.

Moreover, the repos have the potential to reach a much broader range of firms because money funds and investment banks are eligible to participate. In contrast, the interest paid on excess reserves only goes to deposit-taking banks, which have become a relatively small part of the overall financial system, he said. “I would think the [reverse repo rate] was the most important rate” for Fed policy, given who would be affected by it, Mr. Bullard said.

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Putin’s Tipping Point?

Nina L. Khrushcheva

JUL 22, 2014
Malaysian Airlines crash

NEW YORKWhen incompetence in the Kremlin turns murderous, its incumbents can begin to tremble. As news of the downing of Malaysia Airlines Flight 17 over Ukraine trickled into Russia, people with a long memory recalled the Soviet Union’s attack, 31 years ago this September, on Korean Air Lines Flight 007, and its political consequences.

Back then, the Kremlin first lied to the world by saying that it had nothing to do with the missing KAL plane. Later it claimed that the South Korean jet was on an American spy mission. But, within the Soviet leadership, the incident was a tipping point. It ended the career of Marshal Nikolai Ogarkov, Chief of the General Staff and a hardliner of the hardest sort, whose inconsistent and unconvincing efforts to justify the downing of the plane proved deeply embarrassing to the Kremlin.

Ogarkov’s ineptness (and inept mendacity), together with the mounting failure since 1979 of the Soviet Union’s war in Afghanistan, exposed the system’s advanced decrepitude. The stagnation that had begun during Leonid Brezhnev’s rule deepened after his death in 1982. His successors, first the KGB’s Yuri Andropov and then the Communist Party Central Committee’s Konstantin Chernenko, not only had one foot in the grave when they came to power, but were also completely unequipped to reform the Soviet Union.

The huge loss of life in Afghanistan (equal to the United States’ losses in Vietnam, but in a far shorter period of time) already suggested to many that the Kremlin was becoming a danger to itself; the attack on a civilian airliner seemed to confirm that emerging view. It was this realization that spurred Mikhail Gorbachev’s rise to power, as well as support among the leadership for Gorbachev’s reformist policies of perestroika and glasnost.

Of course, history is not destiny, but one can be sure that at least some in Russian President Vladimir Putin’s entourage, if not Putin himself, have been thinking about Ogarkov’s failure and its impact on the Soviet elite. After all, Kremlin leaders, Putin included, define themselves through what was, not what could be.

Indeed, Putin’s rationale for annexing Crimea closely resembles Brezhnev’s reasoning for invading Afghanistan: to confound enemies seeking to surround the country. In 2004, speaking to Russian veterans about the Afghan invasion, Putin explained that there were legitimate geopolitical reasons to protect the Soviet Central Asian border, just as in March he cited security concerns to justify his Ukrainian land grab.

In the Brezhnev era, expansionist policies reflected the country’s new energy-derived wealth. Putin’s military build-up and modernization of the past decade was also fueled by energy exports. But Russia’s latest energy windfall has masked Putin’s incompetent economic management, with growth and government revenues now entirely reliant on the hydrocarbons sector.

Moreover, Putin’s incompetence extends far beyond the economy. His security forces remain brutal and unaccountable; in some parts of the country, they have merged with criminal gangs. His managed judiciary provides no comfort to ordinary people; and the country’s military installations, submarines, oilrigs, mining shafts, hospitals, and retirement homes regularly blow up, collapse, or sink, owing to neglect and zero liability.

When public support for Putin’s annexation of Crimea wanesas it will – his failings will shine more starkly in the light of the MH17 catastrophe. If the Russian state functioned well, Putin could continue to withstand pressure from opposition leaders. But the opposition’s charge that Putin’s regime is composed of “swindlers and thieves” will resonate more strongly, because Russians can now see the results all around them.

By making himself, in effect, the state, Putin, like the gerontocracy that collapsed with Gorbachev’s rise, is increasingly viewed as responsible for all state failures. And though thoughtful Russians may be hostages to Putin’s arrogance and blunders, the rest of the world is not. Indeed, his partners particularly the other BRICS countries (Brazil, India, China, and South Africa) – are now unlikely to be able to turn a blind eye to his contempt for international law and for his neighbors’ national sovereignty, as they did during their recent Brazilian summit. And Europe’s last blinders about Putin seem to have fallen, with the result that serious sanctions are almost certain to be imposed.

Putin is only 61, a decade younger than the leaders who led the Soviet Union to the precipice, and the constitution permits him to remain in power for at least another ten years. But with GDP up by just 1.3% in 2013 – and with sanctions likely to hasten the economy’s declinepatriotic pride will not be able to shield him much longer.

By overplaying its hand in Afghanistan and lying to the world about the downing of KAL 007, the Soviet regime exposed and accelerated the rot that made its collapse inevitable. There is no reason to believe in a different fate for Putin’s effort to re-establish Russia as an imperial power.

Nina L. Khrushcheva is a professor in the Graduate Program of International Affairs at the New School in New York, and a senior fellow at the World Policy Institute, where she directs the Russia Project. She previously taught at Columbia University’s School of International and Public Affairs, and is the author of Imagining Nabokov: Russia Between Art and Politics and The Lost Khrushchev: A Journey into the Gulag of the Russian Mind.