Q3 GDP Is Estimated at 2.0%, and Bond Buyers Give the Govt Money

I’ve given four speeches in the last week, and I’ve started them all with the simple observation that the world has gone crazy. How else can it be explained? In the past 2 years we have provided financial institutions with a governmental backstop (if Citi got into trouble today, we all know what would happen, Ben Bernanke’s phone would ring), hundreds of billions in loans and guarantees, hundreds of billions in direct stimulus, and over $1.5 trillion in newly printed money that was used to buy mortgage backed securities and now US treasury bonds.  The Fed is now neck and neck with Japan as the second largest holder of US treasuries in the world. 

For all of that, GDP peaked in late ‘09 with inventory building and began to decline.  Q2 was 1.7%, but that was AFTER two revisions lower from an original estimate of 2.4%.  Will the 2nd estimate of Q3 GDP be lower?  I don’t know, but it would seem to be a safe bet given that almost all revisions of estimates have been lower in the past several years.  We are obviously on an unsustainable path, as GDP remains, through the rose-colored glasses of the government, stubbornly low.  When viewed in light of all the stimulus, spending, and bailouts, it is almost unimaginable that we are here, stuck, at a low level that does nothing to assist in the rebound of employment. 

But it’s not for lack of trying.  The US govt is pulling out all the stops, doing things that used to be unimaginable – printing dollars and buying treasuries.  That’s the stuff of third world countries, where the central bank enables the government by printing currency.  It seems investors think it’s a sham as well, as they paid $105+ for TIPS (treasury inflation protected securities) earlier this week.  The interest rate paid on these bonds fluctuates with inflation.  If inflation remains flat, then investors will be paid back $100 in five years, having lost 5%  ($105-$100) in that time.  What investors are banking on is that the treasury buying spree of the Fed, using newly printed dollars, will cause inflation to return.  Good luck with that.

The reason I am skeptical is that “core inflation,” which is what the government uses to estimate inflation, excludes food and energy, which are the two areas where we are currently seeing sky-rocketing raw costs – soy, corn, wheat, butter, eggs, meat, and oil.  It is simple to see – when the Fed prints dollars, hard assets go up in value as the US dollar falls.  Unfortunately for TIPS buyers, the largest input of “core inflation” is housing cost, or Owner’s Equivalent Rent.  With all of the housing issues, home prices continue to fall.  Now, that would be great for consumers, except those with EXISTING mortgages don’t participate in that decline, we just keep paying on the declining asset.  However, from the government’s point of view, since new sales are at lower levels, and new rental agreements are at lower levels, we are all benefiting from lower prices.  Seems like magic, doesn’t it?

The economic world has gone crazy.

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