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The Fed's Spoken, but the Numbers Said It All

Frank Trotter | October 1, 2016 3 MIN READ

So, at the time of this writing, the Fed has just announced what many, including myself, had anticipated: There will be no rate change in September. The status quo shall persist until at least December. The markets were less than shocked by the news, as the U.S. 10 Year Treasury Note barely budged and overall stocks held in a tight range. Interestingly, it wasn’t that long ago that the same 10 Year Note would have moved and traded by as much as one-half of 1% during a single day. The reason for this, you ask? Simple. Because back then, the markets held no real consensus on the direction interest rates might take. Fast forward to present time, and from all indications, the invisible hand of the markets continues to anticipate, and receive, lower for longer.

December? Really?

Over the last 12 months, the Consumer Price Index has risen by a whopping 1.1%. This is a slight uptick from where we stood last month, yet still barely half of the 2% figure as espoused by the Fed as its threshold or target number for pulling the rate hike lever. Meanwhile, our friends at the American Institute of Economic Research, in applying their Everyday Price Index, have determined that prices actually fell by 1.2% over this same 12-month timeframe.

The Fed has said that a move is now more likely to occur in December. I find this particularly perplexing given the Fed’s dual mandate of inflation and employment. Prices seem fairly stable right now even after a large run up in commodities. And so I ask, “What exactly is wrong with that?”

In Other News, Can Consumption Kill?

In a future article, we’ll do a deep dive into the underlying mechanics and economics behind the Gross Domestic Product (GDP). Insomniacs take note. But for now, we’ll simply skim the surface, as it’s an important measure of growth that always weighs heavily on the minds of central banks around the world. And today, three of the largest central banks—the U.S. Fed, the European Central Bank, and the Bank of Japan—must feel all alone as their various legislative branches have checked out and cannot be found to fulfill their Keynesian obligations, which some of us might consider fortunate. As a result, all three have created policies and taken actions they believe will result in higher economic growth—otherwise known as GDP.

To arrive at the GDP figure, as you may recall from high school economics, we use the following calculation: C (consumption) + G (government spending) + I (business investment) + NX (net exports) = GDP. Clearly, this will only provide us a best guess estimate, as no reporting budget could ever allow us to literally add this up. Here in the U.S., here’s the typical weighting of the various GDP inputs as they relate to percentage of total GDP:

  • Consumption: 69%
  • Government spending: 17%
  • Business investment: 17%
  • Net exports: -3%

Consumption is interesting, and not only because it is the largest input, but also because there is no accounting of true value. For example, paying $50 for an item creates $50 of GDP, while paying $500 for a like item with a designer tag yields $450 more to GDP, but no additional practical utility. Renowned financial author Bill Bonner likes to note how cutting your own grass adds nothing to GDP, while hiring your neighbor to cut it for $20 adds $20 to GDP, and if you cut that neighbor’s grass for $30 a total of $50 of GDP is generated. Redistribution sounds more appropriate, or trickle down.

While the ability to consume relies heavily on the theory of comparative advantage, we worry that economies dominated by consumption—and with minimal production—rest on shaky piers. It reminds me of a long-ago visit to an old cemetery in Bermuda. While there were various causes of death represented, there was an unexpectedly large population that had succumbed to Consumption. I hope our economic graveyards 500 years from now are not filled with stones marked the same.

Frank Trotter
Frank Trotter
Executive Vice President, Chairman Global Markets
Frank Trotter
Frank Trotter
Executive Vice President, Chairman Global Markets
Frank has over 35 years of experience in banking and global markets. When not in the office, you might find him speaking on the financial conference circuit, giving an interview on the latest world economic news, or at the nearest ice rink playing pick-up hockey.

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