Five Things You Need to Know: Inside the CPI; Deflation; While Rome Burns, Freddie Mac Fiddles at the Ritz; Citigroup and Deflation; It's Not Greenspan's Fault
What you need to know (and what it means)!
Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Inside the CPI
The Consumer Price Index increased 0.8%, the most since September 2005, according to the Labor Department.
- Consumer prices increased 4.3% year-over-year, the most since June 2006.
- The core rate increased 2.3% year-over-year, up from 2.2%.
- Although we've seen a number of news stories referring to the CPI data as "broad-based," a closer look inside the report shows this is not exactly the case.
- The core increase was led by an increase in Apparel and Transportation.
- The move in Apparel, up 0.8%, was outsized, the largest in eight years.
- Transportation was also sharply higher, up 2.9% compared to .4% in October and .1% in September.
- Meanwhile, furniture, electronics, appliances, household products, toys, jewelry and hotel rates were all flat or lower.
The inflation data will offer more fodder for the FOMC inflation hawks at the next meeting, but in our view it is ultimately deflationary, and gold and the dollar this morning seem to agree.
- But why?
- Check out this chart from the Fed showing the adjusted monetary base.
- A common misunderstanding is that falling prices causes deflation.
- So, look at the PPI and CPI, they're going up, clearly causing inflation, right?
- No. Deflation causes prices to fall.
- A decrease in the supply of money or credit and a decrease in the demand for goods related to the inability to access credit is a perfect deflationary cocktail.
- You will know it in the market by a rising dollar, falling interest rates, declining stock market.
- But what about stagflation? Remember, stagflation is simply the temporary transition from inflation to deflation.
- Looking ahead, we will be talking about deflation in 2008, not inflation.
3. While Rome Burns, Freddie Mac Fiddles at the Ritz
Earlier this week Freddie Mac (FRE) CEO, Richard Syron, said the mortgage finance company could lose an additional $5.5 bln to $7.5 bln over the next few years, thanks to credit losses. Meanwhile, yesterday, Bear Stearns (BSC) analysts issued a note saying the government-sponsored enterprise probably has enough capital to "meet challenges," at least through 2008. What kind of challenges? We're glad you asked.
After last month, issuing $6 bln in preferred stock and slashing its dividend to 25 cents, the company was able to scrape together just enough cash to hold their "Single Family Holiday Event" at the Ritz-Carlton Hotel in Tyson's Corner, VA. See below, thanks to a giving-minded Minyan who witnessed the event up-close-and-personal:
Wow, Salon I & the Foyer at the Ritz? What does that get you?
According to the Ritz -Carlton, it's a "classic formal ballroom setting with crystal chandeliers and wall sconces, silk wall coverings and crown molding. The spacious foyer area is perfect for a cocktail reception with panoramic windows, soft seating, antique credenzas and a Steinway grand piano ideal for elegant music."
Our Minyan attendee noted, "They had a laser printer that printed pictures on chocolate lollipops for the kids, hors d'oeuvres, entertainment. You'd think it was the Goldman Sachs partners' dinner!"
Except it wasn't. It was just a government-sponsored enterprise throwing an extravagant party at the Ritz-Carlton just before they are going to need a taxpayer bailout.
4. Citigroup and Deflation
Citigroup (C) yesterday said it will take over seven structured investment vehicles (SIVs) and assume $58 bln of debt to avoid forced sales at distressed prices. Shortly afterward, Moody's lowered the bank's credit rating to Aa3, the fourth-highest level, from Aa2, according to Bloomberg.
- So why is Citigroup bringing these assets back onto its balance sheet?
- Because the Super-SIV didn't work.
- Why didn't it work?
- Because, as Minyanville's Mr. Practical noted this morning, there's nobody left that's dumb enough to finance the debt.
- Fine, but what does this mean for Citi specifically, and why is the stock currently up 2%?
- An analyst raised his rating on the stock this morning, saying he believes the new CEO will be aggressive in raising capital.
- Sweet. Except that to raise this capital he's probably going to have to pursue a path that is highly dilutive, issuing more stock.
- Again, the news today on Citi is part-and-parcel with deflation.
- When credit expands, nominal prices rise as there is more debt to buy things and the more debt, the more the currency devalues relatively. Hey, been there, seen that!
- When credit contracts, however, people have less access to credit to buy things and prices begin to drop. This is how deflation causes prices to fall, not the other way around.
- As Mr. Practical noted, Citi's move today is a sign of deflation: the recognition that the debt cannot be financed or sold to investors.
5. It's Not Greenspan's Fault
Former Fed Chairman Alan Greenspan was on National Public Radio this morning with Steve Inskeep discussing, among other things, the probabilities of a recession and his role in the housing bubble. Some interesting nuggets we found are below (you can listen to the entire replay of the interview on NPR):
INSKEEP: There is a simpler version of this story that is sometimes told: Alan Greenspan lowered interest rates, fueled a housing bubble and got us into a lot of the trouble that we're in right now. What's wrong about that analysis from your point?
GREENSPAN: It doesn't coincide with the facts. First of all, we've had housing bubbles in two dozen or more countries around the world all of which look almost identical to ours and the reason why we've had these bubbles everywhere is everybody's long term rates have gone down, and that in turn I trace back to the extraordinary events that occurred when central planning became an obviously inefficient way to operate an economy.
What Mr. Greenspan says is largely true. Can you blame a central banker for acting like a central banker? But he provided an extremely important clue to understanding what is currently happening, and why it is spilling over into the broader economy.
According to Greenspan, "there's only one thing we could have done [to prevent the housing bubble], cutting off short-term credit. That would have broken the back of the economy, and brought the housing boom down."
The irony is that the market is now, even as we sit here, doing for the Federal Reserve and other global central banks what they cannot do for themselves... cutting off short-term credit. Cutting off short-term credit does indeed "break the back of the economy," which is where are right now.
And just as central banks were incapable of pursuing a path to "prevent the housing bubble," so too are they incapable of re-igniting it. Central banks can facilitate the availability of credit, but they cannot force borrowers to accept it or lenders to lend it.
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