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Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2)

by Dr. Daniel ThorntonD.L. Thornton Economics


Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2) - Inflation cartoon 07.22.2014


I have had a couple of responses to my impending-inflation-disaster essay suggesting that I’m the “boy who cried wolf.” They note that I (here) and others have been concerned about the potential inflation effects of the Fed’s QE policy for some time. But there’s been little smoke and no fire.


I am aware of the fact that the empirical relationship between money and inflation has been essentially nonexistent since the early 1980s. Indeed, early last year I argued (here) that neither the Phillips curve theory nor the monetary theory of inflation has credible empirical support.

Nevertheless, I am inclined to be concerned about inflation when money is growing abnormally fast; especially, when the rapid growth is the consequence of central bank monetary policy. The reason is the theoretical link between money and inflation is strong. Specifically, the price level is the price of goods and services in terms of money, so there is a direct link between money and prices.

According to the Phillips curve theory, inflation is related to the output gap (the gap between actual and potential output). The theory is based on the idea that there is a limit to how much an economy can produce or how fast an economy can grow. Hence, prices would rise whenever people tried to purchase more output than the economy could provide. Whether such limits exist and what they would be is an interesting metaphysical investigation.


Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2) - thornton figure 2

Economists have no idea what these limits are or how to measure them.


But, they try. No matter how potential output is estimated it turns out to be little more than a trend measure of real output. Hence, when output goes substantially above its previous trend for a period of time, as it did during the period 1995-2007 (see Figure 2 above), estimates of potential are ratcheted up. Because output has been significantly below estimates of potential since 2007, estimates of potential have been ratcheted down annually (see Larry Summers, Figure 1 below).


Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2) - summers figure 1

This doesn’t bother true believers.

The Phillip curve theory is nearly always wrong about inflation, but it’s never wrong! It’s a tautology. If the output gap is small and inflation accelerates, believers say “this proves the Phillip curve theory.” If the output gap is small and inflation decelerates, believes say, “the output gap is bigger than we thought.” With this kind of logic, you can never be wrong!

So here is the bottom line of this essay. I don’t know if the massive increase in M1 will ultimately result in an inflation disaster, that’s why the titled of the essay had a question mark. The relationship between M1 and inflation since the early 1980s suggests it won’t. Nevertheless, I believe it is reasonable to sound the alarm because:


  1. There is a direct theoretical link between central bank created money and prices
  2. The increase in M1 that has occurred is unprecedented, and
  3. M1 will continue to grow rapidly so long as the Fed’s balance sheet remains large.


This is a Hedgeye Guest Contributor research note written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.

4 Cartoons: This Week on Wall Street

Our cartoonist Bob Rich captures the tenor on Wall Street every weekday in Hedgeye's widely-acclaimed Cartoon of the Day. Below are his five latest cartoons. We hope you enjoy his humor and wit as filtered through Hedgeye's market insights. (Click here to receive our daily cartoon for free.)




1. Truth (1/6/2016)

4 Cartoons: This Week on Wall Street - Wall Street cartoon


The truth? Wall Street's estimates of the number of jobs added by the U.S. economy in a given month are a joke


2. Eating Crow (1/5/2016)

4 Cartoons: This Week on Wall Street - Brexit cartoon 01.05.2016


"Oh have the Brexit Bears been wrong," writes Hedgeye CEO Keith McCullough. The FTSE hit yet another post-Brexit high today after the U.K.'s Services Purchasing Managers' Index (PMI) for December accelerated to 56.2 versus 55.2 in November. We still like the Pound on the long side, especially against the Euro.


3. Belly Up? (1/4/2016)

4 Cartoons: This Week on Wall Street - GOLDfish cartoon 01.04.2016


Gold prices are down -16% since peaking in early July. We say sell it.


4. "Euros Keep Falling On My Head" (1/3/2016)

4 Cartoons: This Week on Wall Street - Euro rain cartoon 01.03.2017


The Euro has weakened -11.5% versus the U.S. Dollar since last May, as the U.S. economy strengthens and Europe fumbles on fixing its many issues.


Click here to receive our daily cartoon for free.

Cartoon of the Day: Truth

Cartoon of the Day: Truth - Wall Street cartoon


The truth? Wall Street's estimates of the number of jobs added by the U.S. economy in a given month are a joke.



Click here to receive our daily cartoon for free.

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ICYMI: Are You Bullish On The U.S. Dollar Yet?


“Mr. Macro Market is reading today's Jobs Report as bad for long-term bonds, Gold, etc. It’s bullish for the US Dollar, Higher Beta and Cyclical Stocks, etc.”

–Hedgeye CEO Keith McCullough


The December Jobs Report released today showed the U.S. economy added 158,000 net new jobs. On a year-over-year basis, jobs growth was 1.51%. In other words, the growth rate slowed from 1.58% for the month of November. This is a continuation of the downward trend for jobs growth (which peaked at 2.3% in February 2015).


Still, the number may be reaching an inflection point, in which the growth rate bottoms or even reaccelerates (click here to read more). The labor market is one of the only economic indicators not accelerating.


In other words, if the bottom is coming, that’s a bullish signal for #GrowthAccelerating macro positions. 


Plain and simple… buy the U.S. Dollar (UUP). It will trade up too on stronger U.S. growth.


(Note: A stronger dollar also lifts U.S. equities. Check out the 0.78 positive correlation, over the past 90 days of trading, between the dollar and the S&P 500 in the video above. This means they generally trade up (or down) together.)

5 Things to Watch In Washington as Inauguration Day Draws Near

5 Things to Watch In Washington as Inauguration Day Draws Near - z tru oba


Just two weeks away .. Donald Trump will be inaugurated and take control of the White House. As an exuberant U.S. stock market continues to power ahead, the question becomes will Trump deliver the promised goods? He has vowed to make a number of significant changes -- from building a wall with Mexico to rolling back Obamacare.


Here's a quick look at key issues investors should keep an eye on.



#Moscow #Putin


5 Things to Watch In Washington as Inauguration Day Draws Near - z hack


Maverick Republican Senators John McCain and Lindsey Graham look to continue their foreign policy criticism of whomever the occupant at 1600 Pennsylvania Avenue may be. Both Senators are pushing for full investigations into the Russian hacks. And they will challenge Trump on his negative assessments of the U.S. intelligence community.


Other Senators are not ready to criticize Donald Trump in this realm, exposing a rift between those who aren’t quite ready to stand up to the president-elect.





5 Things to Watch In Washington as Inauguration Day Draws Near - z denied


In what could be the biggest surprise of the early legislative session is the Republicans plan for a 2017 ACA replacement bill. Previously it was expected that the replacement would take two to three years to be unveiled, but the looming threat of +20 million people without health care seems to have lit a fire under the new Congress. HHS Secretary-designate Tom Price and Hill Republicans will have their work cut out for them in the coming months.



#Mexico #Immigration #Wall


5 Things to Watch In Washington as Inauguration Day Draws Near - z mex 

After spending sixteen months on the campaign trail insisting that Mexico would pay for a border wall, President-elect Trump acknowledged that the U.S. taxpayer may end up footing the bill after all. Using a bill passed during the Bush Administration, Republicans believe they can attach wall funding to a spending package in April potentially forcing a government shutdown showdown with the Democrats. Don’t worry - Trump took to Twitter insisting that Mexico will foot the bill at the end of the day.



#Cabinet #Trump #WhiteHouse


5 Things to Watch In Washington as Inauguration Day Draws Near - z cap o


In five days multiple Senate committees will be all hands on deck on what is slated to be an unprecedented and busy day on Capitol Hill holding hearings for Trump’s cabinet nominees. The not-so-secret goal of holding five of the hearings in one day is to prevent any one pick from dominating the news cycle - some of Trump’s nominations have attracted unwelcome scrutiny and Senate Leadership is hoping to put it all out there on one day making coverage difficult.



#SupremeCourt #Senate


5 Things to Watch In Washington as Inauguration Day Draws Near - z boys


The war of words between Senate Majority Leader Mitch McConnell and Minority Leader Chuck Schumer has already begun over the Supreme Court vacancy. After Schumer announced that Democrats will not settle for just any nominee, McConnell claimed that America will not support the blocking of a nominee.


The list of potential Trump nominees makes Senate Democrats cringe potentially forcing McConnell to pull the “nuclear option.”


What The Media Missed: Jobs Growth Isn't "Surging." It's Slowing

What The Media Missed: Jobs Growth Isn't "Surging." It's Slowing - help wanted 1 6


BREAKING: The Bureau of Labor Statistics is 90% sure that the U.S. economy added somewhere between 42,000 and 270,000 jobs in the month of December.


Wait, what?


That's right. The BLS, which is charged with calculating montly jobs gains, released today's labor market report showing 156,000 new jobs were added in the month of December. But based on the way this data is collected, the U.S. economy may have added or subtracted an additional 114,000 jobs from that initial jobs estimate.




Interestingly, and more importantly, year-over-year jobs growth continued to slow. To be precise, jobs growth has slowed from 2.3% (year-over-year) in February 2015 to today's rate of 1.51%. The year-over-year growth rate captures the big picture better than blindly staring at these uncertain monthly oscillations. The long-term trend is that jobs growth continues to slow.

These nuances got lost in the shuffle of mainstream media headlines


Most media outlets suggested that jobs growth has been chugging along. Nevermind that the 156,000 number missed Wall Street consensus' estimate of 180,000. Here's mainstream media reporting on this morning's jobs report:


  • CNN Money: "The U.S. job market kept up its overall momentum right up until the end of 2016."
  • MarketWatch: "The U.S. added 156,000 new jobs in the final month of 2016 and worker pay rose at the fastest pace since the Great Recession, reflecting a surge in employment over the past six years that’s left many companies complaining about a shortage of skilled labor."

Chart of the Day: The Absurdity of predicting Monthly Jobs Growth 


Now take a look at today's Chart of the Day below. This captures the wide range of possible outcomes for the BLS's calculation of monthly jobs growth. This should throw cold water on anyone trying to come up with a montly estimate. Alas, Wall Street continues to guess. Here's Hedgeye U.S. Macro analyst in today's Early Look note published just before the 8:30 a.m. Jobs Report:


"Below is a friendly updated reminder from the BLS on the standard error in the NFP estimate.  To summarize, if NFP prints +114K this morning, the BLS is 90% sure we gained between 0 and 228K jobs."


In other words, Wall Street consensus should know better than to predict 180,000 jobs in December. With a range of plus or minus 114,000 jobs for a given month, economists could just as easily pull their nonfarm payroll estimate out of thin air.


What The Media Missed: Jobs Growth Isn't "Surging." It's Slowing - BLS CoD  2


P.S. If you'd like to dig into this a bit further, here's the exact language from the BLS explaining in detail the chart above and how the monthly Jobs number is derived:


"What does this chart tell us? The red dot for total nonfarm employment shows a gain of 161,000 jobs in October, as we reported on November 4. That number is an estimate based on our montly sample survey rather than a complete count of jobs each month. Different samples of employers might give us different estimates of employment change.


We can measure the sampling error, the variation that occurs by chance because we collected the number from a sample of employers instead of all employers. With our measure of sampling error, we can calculate a confidence interval. The blue bar for total nonfarm shows the 90-percent confidence interval ranged from 46,800 to 275,000.


We call this a 90-percent confidence interval because, if we were to choose 100 different samples of employers, the October nonfarm employment change could be between 46,800 and 275,000 in 90 of those samples."

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