Posts from — June 2009

Martin Feldstein’s column, (June 29, 2009) on inflation opines that while federal stimulus is still necessary, a combination of looming deficits, federal reserve bond purchases, and skittishness of foreign investors are pushing yields on the 10 Year Treasury up to alarming levels.

Feldstein’s major premise is detailed in the second paragraph of his column: Higher Yields have led to higher mortgage rates, reducing home buying, depressing net worth tremendously in the last six months. Further, lower home prices have caused more defaults and “weakened bank balance sheets”.

Lets correct some facts: Between 2006 and Six Months ago (December 2008), house prices dropped 27 percent. From December 2008 to March 2009 - the latest month of data,  housing prices fell comparatively 7%. Further, August 2009 Futures for Case-Shiller Composite index is currently trading at 152.0 slightly above where the index level stood in December of 2008, bookmarking the recent rise in treasury yields.

Feldstein, in his column, notes that the current spread between 10-year TIPS and 10 year Treasuries shows an inflation expectation of 2% annually. That inflation predictions have “jumped” to slightly over 2% per year is hardly alarming. 2% is often seen as an inflation target. That the jump in rates is perpetrated by fears foreign investors may no longer continue to buy US debt is simply not true.

China, most notably, while making loud noises is in a “dollar trap”, argued most notably by Paul Krugman. Fail to purchase US Treasuries, and decline the dollar’s value, making our goods cheaper and China’s goods more expensive, ending China’s competitive advantage in manufacturing.

At a high-level, if manufacturing in China continues to keep durable good costs down, and the Federal Stimulus package will improve roads and cargo lines, reducing transportation costs, price increases outside of energy spikes are hard to imagine for durable goods measured in CPI.

Perhaps Feldstein’s view of investor skittishness and his call for the Fed to assure the markets it will curb future “inflationary lending” are really directed at asset inflation: Perhaps investors believe that while policy makers are acting vigorously, nothing structurally has or is going to change to prevent another asset bubble similar to house price inflation witnessed over this past decade.

Asset inflation, be it houses or equities, is much harder to prevent than inflation in durable goods. Let us hope our fiscal stimulus and monetary policy are giving the economy surer footing to produce more, sharing those productivity gains across a wider spectrum, ensuring a diverse economy in the odds of preventing future asset bubbles.