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Personal Finance Blog By MoneyRates - October 2012

3 truths on saving the economy

October 31, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Some of the leading names in the financial industry released a letter to President Obama and Congress last week, urging them to take action to avoid the upcoming fiscal cliff. While the letter did not offer any specific solutions, it did underscore three truths about what it will take to save the U.S. economy.

Writing on behalf of the Financial Services Forum, the leaders of Goldman Sachs, Bank of America, JP Morgan Chase and several other large financial institutions called for a bipartisan effort to address the U.S. budget deficit responsibly. There are two elements to this. The first is avoiding the draconian fiscal cliff of tax increases and budget cuts due to take effect next year. The second is to put in place long-term measures to bring the deficit down over time.

The hard truths

Here are three truths about the budget crisis that the Financial Services Forum letter brings to the fore:

  1. The solution lies in fiscal, not monetary policy. Current mortgage rates are already at record low levels -- and unfortunately, so are rates on savings accounts and other deposits. In any case, the Federal Reserve has gone about as far as it can in its attempt to stimulate the economy with low interest rates. The letter cites comments from Fed Chairman Ben Bernanke last month that confirmed that no amount of monetary policy could negate the damaging economic effects of the fiscal cliff.
  2. The devil will be in the details. The letter is short on details, which may be a function of the fact that the letter was signed by 16 top executives. Getting such a large group to agree on a detailed proposal would have been much more difficult than getting them to broadly call for bi-partisan action. However, having such an influential group get behind some of the unpopular necessities that it will take to address the budget deficit might have helped provide some political cover for Congress and the president.
  3. Enlightened self-interest is the key. Though the letter avoided details, many in the financial community are on record as saying it will take a combination of entitlement reform and tax increases to adequately address the problem. While there are influential lobbies adamantly opposed to those changes, a little enlightened self-interest would create room for compromise. After all, younger people tend to be skeptical about there being anything left of Social Security by the time they retire, so why would they object to an increase in the eligibility age if that might keep the program solvent? As for taxes, there's a good chance that the wealthy would see their investments perform much better if a credible deficit-reduction program were put in place that it would easily compensate for a moderate tax increase as part of that program.

The reality is that it will take awhile for the dust to settle after the election before action can be taken. By that time, the fiscal cliff will be that much closer.

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More worries for the Fed: Inflation powers through September

October 19, 2012

| MoneyRates.com Senior Financial Analyst, CFA

This week the Bureau of Labor Statistics (BLS) announced that inflation had flared up for the second consecutive month. From average Americans with savings accounts to Ben Bernanke and the Fed, rising prices could change how people look at their financial responsibilities.

The BLS found that the Consumer Price Index rose by 0.6 percent in September, the second consecutive monthly increase by that amount. Over the past year, inflation is still just a mild 2.0 percent, but considering that more than half of that increase occurred in the last two months, it is the recent acceleration of inflation that is worrisome.

The potential effects of inflation

Here are four things to note on rising inflation:

  1. Wiping out a year of interest on savings accounts. If 0.6 percent doesn't sound like much inflation, keep in mind that this is just one month's increase. If inflation continued at that rate for a year it would amount to more than 7 percent. To look at it another way, September's inflation alone was enough to wipe out the value of a full year's worth of interest on most savings accounts. Taken together, August's and September's inflation were enough to wipe out the value of a year's worth of interest on even the highest-yielding savings accounts.
  2. More than an aberration? Any given month's inflation number can be dismissed as an aberration, but on the heels of an identical increase in August, September's inflation takes on greater significance. Once may be an aberration, but twice starts to look like a pattern. October's inflation number will show whether this has the makings of a trend.
  3. Don't blame the Middle East. As was the case in August, higher gasoline prices were the driving force behind September's inflation. It's customary to expect that higher gas prices were driven by a rise in crude oil prices, but that was not the case in September. Crude oil prices actually leveled off during the month, while retail gas prices continued to rise. It seems it was more domestic supply-and-demand issues rather than crude oil prices that drove gasoline higher this time around. The good news is that so far in October, both oil and gasoline prices seem to have flattened.
  4. Gives them something to talk about. The resurgence of inflation should make for a lively discussion at next week's Fed meeting. If inflation looks threatening, the Fed may have to back off from its low interest rate policies a little bit. Recent improvement in unemployment actually gives them a little latitude to do that. Given the chronic weakness of the job market, it's unlikely the Fed will adjust course just yet, but between the latest job and inflation numbers, it suddenly has a changing set of conditions to take into account.

Between the presidential debates and the World Series, the high inflation number received relatively little press this week, but that may be one more reason to worry. It's generally the economic problems people don't see coming that hurt the most.

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Does sub-8 percent unemployment mean anything?

October 12, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Last Friday the Bureau of Labor Statistics announced that in September, the U.S. unemployment rate dropped below 8 percent for the first time since 2009, falling to 7.8 percent. Obviously, any progress in reducing unemployment is good news, but a closer look at the employment picture shows that this recent improvement is far from an overwhelming success.

A closer look

Here are some notes on how good September's employment report really was, and what effect if might have on the election and the economy.

  1. Is 7.8 percent good? While this is the lowest unemployment has been in over three-and-a-half years, from a historical perspective 7.8 percent is still high unemployment. Over the last 50 years, unemployment has averaged 6.1 percent. In that 50 years, there have really only been two previous periods where unemployment was 7.8 percent or higher for several months: the mid-1970s and the early 1980s.
  2. Is employment gaining momentum? The drop in the unemployment rate was helped by revisions to prior estimates and other technical adjustments. Employers only created a net total of 114,000 new jobs in September, which is not a strong number. The average monthly gain in 2012 has been 146,000 new jobs, and for 2011 it was 153,000.
  3. Will this affect the election? The unemployment rate is now right where it was when Barack Obama took office, so at best this latest drop in unemployment may have neutralized the jobs issue rather than made it a positive for Obama. Over the past 50 years, the only two incumbents with unemployment rates of 7.5 percent or higher this late in their re-election campaigns were Gerald Ford and Jimmy Carter -- and neither one fared too well.
  4. Will this change Fed policy? Improving employment has been a big goal of the Fed's aggressive interest rate policies, and it's doubtful that this one report will give them enough confidence to back off of those policies. In the near-term, a spike in inflation is more likely to get the Fed to change course than improvement in unemployment.
  5. Will this help savings accounts? CD, savings and money market rates have been among the victims of the weak economy, so will strength in employment help rates rise? Not immediately. For savings accounts and other deposits, you'd have to look at this as just a very small step in the right direction. Only when a positive employment trend has been sustained enough to improve the lending environment will most banks step up to the plate with higher rates on savings accounts.

Although round numbers like 8 percent become psychological barriers in finance and economics, the 0.3 percent improvement that drove the unemployment rate below 8.0 percent is probably not substantial enough to have much of a ripple effect, either on the economy or the election. However, if followed up by a similarly strong gain in October, the momentum could be significant. To add a bit of drama, that next unemployment report will come out just four days before the election.

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Lowdown on the slowdown: 5 notes on weakening GDP

October 4, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Last week the Bureau of Economic Analysis (BEA) issued a surprisingly weak reassessment of second-quarter GDP growth. Previously, the BEA had estimated that real GDP grew at a 1.7 percent growth rate in the second quarter, which was already pretty anemic. Now, the latest estimate has dropped that growth rate to 1.3 percent.

In medical terms, the patient may still be breathing, but you'd have to hold a mirror up to his nose to say for sure. Here are five things you should know about this latest evidence of economic weakness:

1. The weakness seems spread across the board

There are three major components to the economy: consumers, businesses and government. The latest GDP report cited slowdowns in personal consumption expenditures and residential investment as among the reasons for economic weakness. So much for the consumer. The GDP report also cited business investment as another source of weakness.

As for the government, the GDP report actually cited "smaller decreases" in government spending as one of the few bright spots for the economy. However, "smaller decreases" aren't going to lead an economic recovery, and remember, this is an election year. Politicians always seem to magically revive spending leading up to an election, with the bill to be paid afterward.

2. This spells more bad news for savings accounts

If you've been waiting for higher interest on savings accounts, you'd better start shopping, because rates are not likely to rise on their own.

3. On the other hand, it is good news for mortgages

On the same day as the GDP revision, Freddie Mac released a weekly report on mortgages that showed rates had reached an all-time low. The only problem with current mortgage rates is they may be so low that lenders have little incentive to approve applicants.

4. This is not an ordinary economic cycle

An ordinary cycle usually goes like this:

  1. Consumers get a little over-extended, so they rein in spending.
  2. The economy shrinks a little while consumers regroup.
  3. The government applies a little stimulus to prime the pump.
  4. Consumers start spending again.
  5. Sensing optimism, businesses start hiring and consumers gain even more strength.

This time around, however, consumers were too far over-extended with debt to make a quick recovery, the government is facing a massive debt problem of its own, and many businesses are seeing their key European trading partners sink into a recession.

5. The GDP estimate is a backward-looking measure of the economy

The good news is it already felt like the second quarter was weak; the GDP report just confirms it. The bad news is the third quarter feels pretty weak as well.

The first measure of third-quarter GDP will come on October 26. Until then, the next indication of how the economy is doing will come with the October 6 employment report. However, with the election extending the mood of uncertainty into the fourth quarter, sustained good news for the economy might not come until the new year.

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