Wednesday, June 25, 2008

Although Commercial Aircraft Orders Are Down, Backlogs Are Still Growing. What About the "Flake Out Factor?"

The Department of Commerce's latest data show new orders for commercial aircraft are down 36.7% from last year. Is that a worry for Wichita? Not yet. The month to month data are very volatile and new orders are down from a very high level last year. The level of new orders was high enough that unfilled orders are still up and I estimate the backlog now represents a healthy 35.4 months of shipments. The new planes, particularly the more fuel efficient planes built of composite, are made to order for today's rapidly rising fuel prices.

But Will it last?

J. Lynn Lundsford and Susan Carey warn in today's Wall Street Journal that "As rising oil prices cause even the strongest airlines to struggle, Airbus and Boeing Co. face the possibility that as many as a third of their orders for new jets could be postponed or canceled." One very savvy observer is Steven Udvar-Hazy, the chairman and founder of aircraft-leasing giant International Lease Finance Corp. which buys many of the planes airlines lease. He "predicts that 25% to 30% of the two makers' order books ... could be subject to what he called the 'flake-out factor' if oil prices continue their unprecedented rise."

This reminds us of a fundamental truth. Orders for aircraft are ultimately tied to the demand for airlines and their profitability. Rising fuel costs make the new generation of aircraft attractive, but they rob airlines of their ability to pay for the newer planes. Financially, U.S. airlines are far from healthy. Christopher Hinton of Market Watch tells us that airlines are cutting back on capacity and laying off workers:

Friday, June 13, 2008

Chile's Central bank To Raise Rates

Chile's Central Bank May Raise Interest Rate as Inflation Soars

By Sebastian Boyd

June 10 (Bloomberg) -- Chile's central bank will probably raise the benchmark lending rate for the sixth time in the past 12 months as policy makers seek to slow the fastest inflation since 1994.

Central bank President Jose de Gregorio will increase the overnight rate by a quarter percentage point to 6.50 percent, according to 12 of 24 forecasts in a Bloomberg survey of 24 economists. Six analysts expect a half-point increase and six expect no change.

Chile's inflation rate has tripled in the 12 months through May to 8.9 percent and is more than twice the central bank's target of 2 percent to 4 percent. Food prices have risen 19.4 percent in the past year, while the cost of crude oil has more than doubled.

``They'll have to raise rates,'' said Rodrigo Valdes, Barclays Capital's chief Latin American economist and a former head of research at the central bank. ``The question is whether by a quarter-point or a half-point, and they'll probably have to raise more down the road.''

Chilean economists raised their 2008 inflation forecast to 5.5 percent, according to a central bank survey published yesterday, up from the forecast of 4.7 percent a month earlier. Stripping out food and fuel costs, the 12-month core rate of inflation rose to 8.4 percent.

``The surprise would be if they do nothing,'' said Benjamin Sierra, head analyst at Bandesarollo Administradora de Fondos in Santiago. ``They're likely to do it now and if they don't, they'll have to in the future as price pressures remain strong.''

Drought, Pause

The central bank has paused at its four meetings since raising rates in January. At their last meeting on May 8, policy makers debated a quarter-point increase, according to the minutes published June 3.

The country's worst drought in a century cut agricultural production while denting hydroelectric output, fanning domestic food and fuel prices.

Rising fuel costs threaten to slow economic growth in Chile, which imports almost all of its oil and gas, the central bank said May 12. The government last week announced $1 billion in fuel subsidies and an 80 percent rebate on diesel taxes for striking truckers.

Since the bank's last meeting, growth has rebounded, with the May economic activity report showing a 4.8 percent year-on- year expansion, more than the 3.5 percent median estimate of 21 economists in a Bloomberg survey.


Chilean economists raised their 2008 forecast for economic growth to 4 percent from 3.8 percent a month earlier, according to the central bank survey published yesterday. Heavy rain has raised water levels in hydroelectric dams, curbing concern of power cuts to mines and cities Chile's south and central regions.

State-owned Codelco, the world's largest copper-mining company, Freeport-McMoRan Copper & Gold Inc. and Anglo American Plc have mines in the area that was struck by drought.

Copper accounted for more than half of Chile's exports last year.

The overnight rate may end 2008 at 6.50 percent and drop to 6.25 percent by year-end 2009, according to the survey conducted by the central bank on June 6.

Economists last month had forecast a 2008 year-end rate of 6.00 percent and 5.75 percent in December 2009.

Chile's peso surged the most in three months on June 5, when the National Statistics Institute published May consumer price data, on expectations the central bank would lift the benchmark rate.

The 4.25 percentage-point difference between the Chilean and U.S. benchmark lending rates, along with gains in copper, the nation's biggest export, has helped fuel a 9.5 percent increase in the Chilean peso in the past 12 months.

To contact the reporter on this story: Sebastian Boyd in Santiago at

Last Updated: June 10, 2008 00:00 EDT

Thursday, June 12, 2008

Jürgen Stark, a member of the executive board and the governing council of the European Central Bank, Explains the ECB's Approach

Why money data are vital to the eurozone

By Jürgen Stark

Published: May 26 2008 18:35 | Last updated: May 26 2008 18:35

These are challenging times for central banks. Inflationary pressures endure. Financial tensions persist. Uncertainty about the outlook for economic activity remains high. In such circumstances, the European Central Bank’s goal remains clear: price stability, in line with our mandate. But, more than ever, we need reliable guides to lead us to this objective.

At the ECB, the money and credit data have proved a crucial signpost. We have long argued that a thorough monetary analysis is central to the determination of interest rate decisions. Not only does such analysis reveal the underlying longer-term inflationary trends in the economy, it also signals the potential emergence of financial imbalances and asset price misalignments that could threaten macroeconomic stability. The close link between monetary developments and evolving imbalances in asset and credit markets implies that monetary analysis can help identify such excesses at an early stage, creating scope for an early preventive policy response. In addition, close monitoring of money and credit data offers an insight into financing conditions, which can strongly influence household and company spending decisions. Each of these elements has proved essential in formulating our response to the financial turmoil seen over recent months.

To illustrate, consider three aspects: the lessons of the past; the experience of the present; and the outlook for the future.

The past: at a time when indicators of real economic developments were – at best – mixed and after an extended period of very low key interest rates, the ECB started to raise rates in December 2005. This decision hinged crucially on the upside risks to price stability identified by the monetary analysis. Subsequent events clearly vindicate this decision. Any further delay in raising rates – which might have followed from neglect of monetary developments – would only have served to exacerbate current inflationary pressures and risked deepening the financial excesses of subsequent years that underlie the recent turmoil. Indeed, given the inflationary pressures apparent in recent data, it appears that the upside risks to price stability associated with the strengthening of underlying monetary growth from late 2004 are now becoming manifest. Some observers even argue that an earlier and more rapid withdrawal of monetary accommodation would have been desirable.

The present: since the emergence of financial tensions in early August 2007, monetary analysis has proved a crucial bulwark for the ECB’s conduct of monetary policy. A close evaluation of the credit data has allowed us to conclude that the availability of bank loans to euro area companies has not been significantly impaired by the financial turmoil thus far. While we continue to monitor developments closely, such evidence has proved an important counter to the gloomy prognosis of “credit crunch” that has driven much of the recent debate on the outlook for the European economy. More fundamentally, the monetary analysis has maintained the necessarily medium-term orientation of monetary policy, at a time when short-term forces threatened to overwhelm it. And it has helped focus our attention on the inflation outlook at longer horizons, over which central banks can exert control and for which they ultimately need to take responsibility.

The future: while the monetary analysis has served us well since the creation of the ECB and particularly in recent months, our experience also points to the need for further development. Enhancing the data, tools and frameworks underpinning the monetary analysis is central to the ECB’s research agenda. Yet the recent financial turmoil also demonstrates that well-established central banking techniques remain valid and important.

Albeit in a somewhat different context, Paul Volcker, former US Federal Reserve chairman, recently emphasised the importance of respecting “certain long embedded central banking principles and practices” in these turbulent times. Such advice is particularly apposite in monetary analysis. We have seen that attempts by banks to shift activity off balance sheet have largely proved to be a chimera, as financial turmoil has forced reintermediation of loans and credit risk. Looking at balance sheet positions of banks, households, corporations and other financial institutions – the “bread and butter” of monetary analysis – should thus again be at the forefront of monetary policy makers’ concerns.

A few days ago, I of course drew pleasure from the Lex column’s recognition of “the ECB’s wisdom” (May 8). As a prudent central banker, I refrain from basking in this unexpected praise. After all, pride precedes a fall. Yet the column sheds important light on my argument. Lex saw the ECB’s “biggest success” as stemming from our “insistence that inflation risks are serious”. While various proximate risks – among others, the rapid increase of commodity prices and the associated potential for second round effects in wage and price setting – are important, it is the analysis of monetary developments that underpins our focus on the outlook for price stability over the medium term that Lex praises. There is no room for complacency in this regard. But, by providing a framework for identifying underlying inflationary trends at an early stage, monetary analysis ensures the ECB remains focused on its mandate, bolstering our credibility and preserving the hard-won goal of price stability.

The writer is a member of the executive board and the governing council of the European Central Bank

Wednesday, June 11, 2008

The Economy Needs Shock Treatment

The chairman of the Federal Reserve has finally noticed that the dollar is making Latin American currencies look strong. His speech to the International Monetary Conference, in Barcelona, Spain was widely interpreted as “jawboneing” the dollar up. What is really needed is shock treatment: a large and unexpected hike in the federal funds rate. Bernanke’s attempt to fight the recession and the credit crunch by flooding the world with liquidity is instead drowning the economy in a flood of inflation and sinking the financial institutions he hoped to save.

What caused the Fed’s Chairman to finally notice the dollar?

Firstly, inflationary expectations are red hot. The market for indexed treasury bonds indicates investors are expecting inflation of 3.4 percent over the next ten years. That is based on data from the Cleveland Fed. Investors are voting with their dollars that the Fed is way off its 1-2 percent inflation target. Households are telling pollsters a similar story. Last month, when the University of Michigan asked consumers what they expected inflation to be over the next twelve months, they answered 5.8 percent. That is the highest reading in twenty-six years. What they told the Conference Board was an even scarier 7.7 percent (a record high survey result.) Lynn Franco, Director of its Consumer Research Center said "Consumers' inflation expectations, fueled by increasing prices at the pump, are now at an all-time high and are likely to rise further in the months ahead." The last time households were this pessimistic about prices, they were the walking wounded still skeptical about Paul Volcker’s epic war against inflation.

Secondly, import inflation is sucking purchasing power out of the economy so fast that it is aborting any potential recovery. Import prices rose 17% over the last year. America imports $2 trillion worth of goods and services. Do the math: that is a loss of purchasing power of about $340 billion. That is more than twice the size of the fiscal stimulus package.

Thirdly, inflation on domestically supplied goods is taking away another $200 plus billion of purchasing power. As inflation gets more and more entrenched, the economy will become progressively more immune to fiscal and monetary stimulus.

Fourthly, the monetary mavens at the Fed have started to realize their big mistake. By focusing on the so-called “core inflation rate,” they took their collective eye off the ball. The Fed has targeted “core inflation” at the expense of “headline inflation.” What the Fed calls “headline inflation” measures the rise in the prices of what we actually buy. Little wonder that makes the headlines. We measure “core inflation” by pretending we do not eat, do not feed the kids, do not heat and cool the house and do not drive the car: we subtract food and energy prices from the price index. The theory is that “If core inflation is OK, we are OK.” The Fed thinks we are OK. A trip to the supermarket would have cured that delusion. While oil prices have had the lion’s share of the headlines, food price inflation has really hit American households hard. It is those trips to the supermarket that have the American consumer hopping mad. Food prices are rising at two and a half times the “core inflation” rate. Consumer inflationary expectations are tracking food price inflation much more than they did in the past. Worse, given the rapid rise in inflationary expectations, this is going to start bleeding into wages and the prices of other goods and services. If you look carefully at the Great Inflation of the 1970s, that nightmare we all want to avoid reliving, food prices consistently led both “headline inflation” and “core inflation.”

Lessons of the 1970s

A sober economic historian would judge the years 1973 to 1982 as the worst decade in the last sixty years. The misery got started when another Fed Chairman, Arthur Burns, pumped up the supply of money and credit to achieve domestic objectives (reelecting the president.) The money supply grew 13.4% and liquidity assets in double digits in 1971. With the dollar as world’s reserve currency, exported his inflation to the rest of the world. The main economies started expanding in unison setting off a global commodity price boom. Oil prices, then as now, only took off after the bandwagon already had a powerful momentum going. In short order, the dollar was devalued and the international monetary system thrown into chaos. New York started losing ground as the world’s financial center to London and others. The economy went into a severe recession as inflation sucked purchasing power out of it and inflation disrupted economic decision-making. After a decade of accelerating inflation and three recessions, economic sanity was restored with much pain and suffering. Vast amounts of wealth were redistributed and unemployment averaged seven percent.

I am experiencing a terrible feeling of déjà vu. In the U.S., an overexpansion of credit caused a house price bubble, particularly for high-end houses. This was fed by and help to feed the creation of ever more complex financial instruments whose connection to the underlying fundamentals was evermore distant. As with all speculative excesses, this one too had to come to an end. As these distortions started to correct themselves, the housing market turned down. The esoteric instruments born in the boom had been sold globally. Investors around the world started to realize that they had bought a pig in a poke and the pig was now starting to stink. The resulting stampede to sell these securities led to a credit crunch. The Bernanke Fed’s initial attempt to deal with the crisis was to flood the world with liquidity and slashing the federal funds rate. The result was uncomfortably like being in a house where someone in the living room is cold. This thin-blooded soul jacks up the thermostat so that everyone else is sweating. A wiser solution would have been to put on a sweater or get a space heater.

Monday, June 02, 2008

A Tip from the TIPS Market: Investors are Expecting More Inflation

Inflationary expectations are growing. That comes across loud and clear from a number of surveys:

When the Conference Board surveyed households in May they found they expected an inflation rate of 7.7 percent for the year ahead (a record high survey result.) Lynn Franco, Director of its Consumer Research Center said "Consumers' inflation expectations, fueled by increasing prices at the pump, are now at an all-time high and are likely to rise further in the months ahead."

The University of Michigan reports that households expect inflation over the next five years to be near 3.4 percent, its highest reading since 1995.

The professional forecasters surveyed by the Federal Reserve Bank of Philadelphia (the old NBER/ASA survey) projects inflation over the next five quarters at 2.5 percent.

Another gauge is the difference between regular treasury bond yields and those on Treasury Inflation-Protected Securities (TIPS.) Currently the spread is 2.45 percent which would appear to indicate that investors expect a 2.45 percent inflation rate over the next ten years. But that may understate investors' true expectations. The Federal Reserve Bank of Cleveland adjusts the raw spreads for liquidity premia. Charles T. Carstrom and Timothy S. Fuerst explain how that is done in a briefing. With this adjustment the implied expected inflation rate is 3.32 percent.