Government estimates GDP at 1.3% for the first quarter

Government reported their estimate for first quarter GDP growth and it came in very low, the lowest level in the past five years. See article from The New York Times. Here's the AP article from Yahoo! Finance.

You may be saying to yourself, well what does it all mean?

I'll tell what I think it means, and I don't think its pretty. Usually, GDP goes down and the Fed acts to counterbalance a slowing economy by loosening monetary policy, which is almost always lowering the Fed Funds Rate (The rate banks charge to each other). Usually with slower GDP growth, prices also go down, because demand goes down. So the Fed acts to "stimulate" the economy. Effectively, they are pumping more money into the system. When more money comes into the economy the value of money goes down, subsequently stimulating inflation, because when you have more of something (supply and demand), its value is lower, making the things you buy higher priced.

This time around, the Fed has another problem. Inflation already is at a level in the economy where lowering rates is not possible, because then inflation would be too high. The NY Times article points out the following:

"The slow growth was not enough to brake inflation. The G.D.P. price index, a statistic closely watched by the Federal Reserve to monitor price fluctuations, jumped 4 percent in the first quarter — the biggest increase in 16 years."

This now becomes a larger problem, because the Fed is unable to act while inflation is high and the economy must work its way out of slow growth on its own, without monetary stimuli. The Fed has to wait until inflation moderates (the economy's demand shrinks to the point where prices begin to drop) before lowering rates. Now some people may claim that we have enjoyed low rates for a prolonged period of time and inflation was low, so we shouldn't expect to rates to stay high or even move higher, inflation will moderate. However, they are missing two important factors that contributed to low inflation. The first thing is productivity growth, which has been around 4% annually for 10 years. This is unprecedented and mostly due to the integration of IT into all kinds of businesses specifically manufacturing. The second thing is globalization, which has kept prices low due to a "world price." Now that second issue will bite back and affect our market more than we would like. We are not the only ones who want cheap electronics and computers, we've helped the developing world growth their economies so now they want to buy these things too.

The reason for this is increasingly due to China and other emerging markets. As emerging markets supplied the rest of the world and grew, their own demand grew, subsequently increasing world demand for all these products and the world demand for basic materials and other commodities.

This means that although we may have slower growth in the United States, due to increased world demand, prices may not moderate. This means the most dreaded economic environment may result, stagflation...This is where inflation is high and interest rates are high. But we won't get to the point of the 70s, we'll probably work our way out of it since the economy is much more diverse. So prices will be tempered by competition due to globalization, just don't expect interest rates to go down.

Consumer Sentiment Down

Consumer sentiment down... sales of existing homes sharpest decline since 1989... oh oh... more later, meanwhile, here's the link from Yahoo! finance ... oh and something about gas prices hurting our demand...

Realtors blamed...wait for it...

POOR CREDIT!!! What's that?

Toyota First Quarter Sales Top GM's

Well, it finally happened...

Toyota first quarter sales top GM's

The truth of the matter is, this metric is meaningless, all we care about is whether GM starts making profit again and that profit comes back into the Detroit metro area. Besides, the automotive industry is going to go through a giant transformation when era of the fuel injection engine begins to decline, after that its anyone's game, so who sells the most is just a metric that GM can use to let the UAW and Detroit know how far we have sunk and that drastic changes are necessary. Without the past year's losses and the devastation in the auto industry, the new leverage that GM has over its bloated labor infrastructure would have never been possible.

Commodities, Energy, and Housing

So over the past couple months we've finally been hearing about the meltdown in the housing market. Finally, all those crazy loans hocked by hopped up phone jockeys, with mediocre college educations, their own bad debt problems, and their perverted views of what is a normal way of living life are finally coming back to haunt these banks that wrote these loans. HSBC declared that they were taking a $10 billion write down to their exposure to sub prime loans. Other banks have fallen suit as other banks and financial companies have gone belly up crushed under their bad debts. But don't worry this is a small segment of the broader giant housing market, it will make a dent, but risk is spread better than you think. Thankfully, financial derivatives have both increased our risk preference and spread that risk as well.

It seems like worse news that it really is. I can rail on about how the fabric of responsible America society is crumbling under Chinese fueled consumerism. DVD players for $49, wow, I'll take six, now I can watch DVDs in every room in the house, let's see the AMEX is maxed, MBNA, Capital One, wait let's try that new one from Bank of Iowa Savings. I'll just refinance the house when the rates go down again. But that's meaningless because that's not the issue and that's not what's affecting the market in the US. The slow and determined shift of economic power away from the United States and to the Far East is happening, and will continue to do so. It's actually great that the standard of living is going up and more products are available to more people. Whether this is creating a higher standard of life is a matter for philosophical discussion that I don't care to talk about now.

Mainly, all this means is our desire for refinancing and consumer goods has been fueling a global boom. Our low interest rates and housing refinancing and subsequent appetite for goods and services has fueled the rise of emerging markets. We are not the only ones to blame, but the Irish, English, Spanish, and various other overheated housing markets. However this has kept the world economy churning for the past five years. Here's the problem, when you have low interest rates, assets become cheaper and building and growth is stimulated. Hey that's a good thing, right, right. But here's what happens, China and India and other emerging economies grow off this boom and become an engine all their own. So when before emerging economies are taking advantage of their labor cost advantage to supply the developed world, their people gain wealth and now must spend on their own, but what do they buy? Goods from the developed world, but also goods from their own country.

These nouveau riche or (middle class really) has grown into a large market all its own, and they want cars, apartments, and DVD players too. Now as demand grows, so does the demand for the basic ingredients and components of all this demand. What are these basic ingredients?

Copper, Oil, Gold, Silver, Natural Gas, Water, etc....

What does this mean for the rest of us? That even as the American economy slows due to our over-extension in housing the price of commodities and energy will continue to be high. Worse, the American economy will have less and less of an impact on the movement of these prices, and further, the American government and the Federal Reserve will become increasingly weaker in controlling its own destiny. Therefore, as China, Brazil, India, and the other emerging markets grow, American influence will temper and we will have to get used to higher prices for energy and commodities. Even as the current prices shake out, they will only moderate slightly as we enter a period of higher costs making energy and commodity efficiency more important.