News programs, magazines, and other forms of media have to provide an audience to their advertisers if they want to stay in business. This results in many stories with exaggerated emotional content that try to hook viewers. We all know how this works and do our best to read between the lines. That is often difficult with stories of a technical nature that take us out of our comfort zones.
During the recession and recovery I have seen a number of programs or articles take an interesting data point that is worth mulling over and use that to speculate on the end of the U.S. economy as we know it. These same spokespeople and authors then treat the next day’s new data point with the same level of heightened emotion. Part of my job is to help you navigate this ever present media noise.
I have recently read and seen some thoughts stating lower commodities prices are worrying as they signal a weakening U.S. economy. It is true that there are a number of speculators within the commodities markets who trade based on their expectations of overall economies in the near future. A pullback of these more speculative positions does not necessarily mean that these speculators see a weakening economy though. We have seen a rise in commodities decoupled from actual demand for the underlying materials. We are now seeing an unwinding of some of the more speculative commodities positions taken in recent months. This does not signal a weakening economy, but rather a return to commodities prices that reflect the actual cost of materials based on real world demand. This return will result in lower prices for some commodities, which will in turn help consumers and their spending power. That will help the general economy, not hurt it.
Higher commodities prices create higher levels of inflation, creating a drag on economies. Lower commodities prices are good for an economy as consumers then have more money for discretionary spending. That is still the bottom line when it comes to commodities and their effect on an economy.
The Federal Reserve is purchasing government debt and increasing the money supply. Money supply growth has kept pace with moderate levels of economic growth and inflation. M2 refers to the total amount of money in circulation outside of bank vaults, savings and checking account balances, money market balances, and similar liquid assets. The May 26th release of the Federal Reserve’s H.6 statistical report1 shows M2 growth of 4.9% over the past year. Even conservative analysts deem this acceptable for an economy whose GDP growth plus inflation are about the same level. Where is the U.S. in terms of GDP + inflation? The Bureau of Economic Analysis’ May report2 notes 2010 4th quarter U.S. GDP at 3.1%, with 2011 1st quarter GDP an estimated 1.8%. The Bureau of Labor Statistics April report is their most recent. They note a year-over-year inflation increase of 3.2%.3 M2 growth is not exceeding the combination of GDP and inflation for the U.S. economy.
A quick look at exchange rates over the past 5 years shows the U.S. above the 5-year average against the Euro and the British Pound.4 We do not have excessive inflation or devaluation of the U.S. Dollar due to quantitative easing. Banks are still not lending at rates high enough to cover reasonable demand. The Federal Reserve’s policy of money supply growth is helping make up for these low lending levels, not fueling runaway inflation or currency devaluation.
What will the inflation rate do? Will we see Zimbabwean effects on the U.S. Dollar, or more moderate runaway inflation such as Argentina saw several years ago? There is much fear in many hypothetical scenarios, but not often much in the way of fact. As noted above, inflation has increased to just over 3%. This is about average for the last decade.5 It has risen since 2009. However, this is due in part to a reversal of the deflationary pressure of the recession and the increase of commodities prices noted above. It is worth noting that the rise in inflation is just a rise to average levels.
Inflation increases due to demand based price pressure. The global economy is still too weak to exert much upward inflationary pressure. Nor is Federal Reserve policy causing inflationary pressure. Inflation will be an area to watch when the economy does revert to higher growth levels, but there is still too much drag on both the national and global economies to stimulate high levels of inflation.
The economic outlook is more of the same. Housing is a weak spot that is not likely to change soon. Unemployment levels are slowly decreasing. Credit is still tight. Companies are still earning profits. The economy is growing, but at a slow pace. It is hard to write an engaging article or retain viewers with headlines of “More of the Same” and “No Change Today”. While the media may have their reasons for speculative narratives surrounding the economy, much of what is said is just noise.
The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.