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Weekly Economic Commentary 5/6/2013

Weekly Economic Commentary 5/6/2013

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Weekly Economic Commentary 5/6/2013
Weekly Economic Commentary 5/6/2013

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Published by: monarchadvisorygroup on May 09, 2013
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Member FINRA/SIPCPage 1 o 6
Weekly Economic Commentary
May 6, 2013
John Canally, CFA
EconomistLPL Financial
Clearing Up Conusion on Common Queries
The Federal Reserve (Fed) is responsible ormonetary policy, not scal policy.The budget decit, guided by scal policy, isdriven by decisions made by Congress and thePresident, not the Fed.The budget decit is likely to continue toimprove in the near term, but the real problemsposed by the ederal debt are the structuraldecits in the Social Security, Medicare, andMedicaid programs, which won’t be helpedmuch by an improving economy.Factors controlled by the Fed and Congress,such as interest rates and trade policy, impactboth the US dollar and the trade decit.
Please see the LPL Financial Research Weekly Calendar on page 3
In this week’s commentary we attempt to clear up some o the conusionaround some o the most common questions we encounter regularly, including:
The Federal Reserve (Fed), its balance sheet, its role in the economy,and its impact on infation;
The ederal budget decit;
The ederal debt outstanding, and the debt-to-GDP ratio; and
The trade decit and a related topic, the US dollar.In many ways, the items above are related. But otentimes, pundits,politicians, newsletter writers, bloggers, Tweeters, and even the “traditionalmedia” will conuse or confate one or more o these issues, and that’susually when we get a call about it in the LPL Financial Research Department.
The Federal Reserve
The Federal Reserve (Fed) was created in 1913 by an act o Congress, TheFederal Reserve Act, to provide “the nation with a saer, more fexible, andmore stable monetary and nancial system.” The Fed was created ater aseries o nancial panics, bank runs, credit crunches, and booms and bustsin the late 1800s and early 1900s. Over time, the Fed’s role in the economyhas expanded, and currently, the Fed has a “dual mandate” rom Congress(via the Full Employment and Balanced Growth Act o 1978) to conductmonetary policy that aims to promote “ull employment and reasonableprice stability.” In plain English, Congress created the Fed to run monetarypolicy, and could, at any time, vote to take away or modiy the Fed’s dualmandate. In act, Congress could run monetary policy themselves i theyvoted to do so, although it would be an understatement to say that marketswould not embrace that outcome were it occur.As part o its mandate rom Congress, the Fed’s policymaking arm, theFederal Open Market Committee (FOMC) can raise or lower the interestrate banks charge each other or overnight loans, and expand and contractits balance sheet (quantitative easing, or QE) to achieve its goals. Since2008, the Fed has pursued several rounds o QE the purchase o Treasuryand mortgage-backed securities (MBS) in the marketplace by creating“reserve credits.” The Fed’s balance sheet currently stands at just over $3trillion, and it is likely to continue to grow over the remainder o 2013 andperhaps beyond.
LPL Financial Member FINRA/SIPC Page 2 o 6
The Fed’s Balance Sheet Has Expanded as a Resulto Quantitative Easing
Source: Federal Reserve Board, Haver Analytics 05/06/13Shaded areas indicate recession.
051095900037503000225015007500All Fed Res Banks: Assets:U.S. Government & Agcy Sec Held Outright
EOP, Bil.$
The Fed’s balance sheet does not add to the ederal decit (see below),nor does the Fed set interest rates in the marketplace — beyond interestrates on overnight lending. Interest rates on everything rom 3-month T-billsto 30-year Treasury bonds are set by the market, not the Fed. While theFed is not responsible or scal policy or the budget decit (see below), anargument has been made that the Fed is encouraging scal policymakers tooverspend by buying the debt issued by the Treasury to und the spending.In all likelihood however, Congress would be spending more than it takesin, and the Treasury would be issuing the debt to und this overspendinganyway. The dierence is that instead o the Fed buying the Treasuries,other entities (the U.S. public, bond unds, pension unds, insurancecompanies, oreign entities, etc.) would be buying the debt, albeit at aslightly higher yield, and a slightly higher cost to the Treasury.The risk o infation rom the Fed’s policies would arise i all the money theFed is pumping into the system (mainly onto commercial banks’ balancesheets) would be lent out all at once by those banks to businesses andconsumers across the country and around the world. While there has beensome lending, lending activity has not been robust, and indeed the velocityo money — the rate at which money sloshes around in the economy hasallen by a third since the onset o the nancial crisis in 2007 08, and showsno signs o reversing. (Please see the
Weekly Economic Commentary: Infation Situation Revisited 
rom March 18, 2013 or more on our view oninfation).In short, the Fed runs monetary policy and is given that mandate byCongress. Our view remains that the Fed will continue its program o QE overthe remainder o 2013, and will keep rates at or near zero until at least 2015.
Federal Budget Defcit
The ederal budget decit is the dierence between what the Treasurycollects in taxes (personal income taxes, payroll taxes, excise taxes,corporate taxes) and ees, less what the ederal government spends (ondeense, social programs, roads, education, etc.). Decits increase whenthe ederal government, authorized by Congress, spends more than ittakes in, and decits decrease when the ederal government takes in morerevenue than it spends in a year. A large percentage o ederal spending isset on autopilot via mandatory spending on programs like Social Security,Medicare, and Medicaid (see the
Weekly Economic Commentary 
romOctober 29, 2012), although smaller portions o the budget (interestpayments on the ederal debt and spending on non-mandatory items) aredetermined by Congress annually.
Fiscal Policy
Fiscal policy (decisions on how the government should raise revenue and/ or manage spending) is made by Congress, with the President having vetopower over what Congress decides. The ederal budget decit (in dollar termsand as a percent o gross domestic product [GDP]), is headed lower, at least
Our view remains that the Fed willcontinue its program o QE over theremainder o 2013, and will keep ratesat or near zero until at least 2015.
The Federal Budget Decit Is Currently Moving inthe Right Direction, but Will Remain a Key PolicyIssue or Years to Come
Source: U.S. Treasury, Haver Analytics 05/06/13Shaded areas indicate recession.
0510959080857500 0.40.0-0.4-0.8-1.2-1.6Federal Surplus {+} or Deficit {-}
12-Month Moving Total, Tril.$
LPL Financial Member FINRA/SIPC Page 3 o 6
20136 May
Eurozone: Service Sector PMI (Apr)
7 May
Consumer Credit (Mar)
Australia: Central Bank Meeting
Germany: Factory Orders (Mar)
France: Industrial Production (Mar)8 May
China: Exports and Imports (Apr)
China: CPI (Apr)
China: PPI (Apr)
Germany: Industrial Production (Mar)
Norway: Central Bank Meeting
South Korea Central Bank Meeting9 May
Initial Claims (5/4)
Wholesale Inventories (Mar)PlosserLacker
UK: Central Bank Meeting
Spain: Bond Auction
China: New Loan Growth (Apr)
China: Money Supply (Apr)
10 May
Monthly Budget Statement (Apr)Bernanke*
G7 Finance Minsters
FedGlobal Notables
LPL Financial Research Weekly Calendar
U.S. Data
Hawks: Fed ocials who avor the low infation side o the Fed’s dual mandate o low infation and ull employmentDoves: Fed ocials who avor the ull employment side o the Fed’s dual mandate* Voting members o the Federal Open Market Committee (FOMC)
over the medium term, helped by tax increases, the sequester spending cuts,the ading impact o the $787 billion American Recovery and ReinvestmentAct (ARRA) o 2009, and the improving economy, leading to higher revenuesand lower spending or items such as unemployment insurance.While this improvement in the overall budget picture is welcome, andsomewhat o a surprise to many, it may lead to complacency, and preventthe policymakers responsible or scal policy rom taking the needed actionsto begin to address our longer-term budget problems.While the Fed has no role in setting scal policy, the Fed’s own policiesdo impact the decit. The Fed’s operations historically earn a prot, as therevenue it takes in via open market operations as well as by check andelectronic payments processing or the nancial system, ar exceed itsoperating costs. The Fed promptly returns all prots back to the Treasury.In 2012, the Fed paid $88 billion into the Treasury, and it has consistentlyreturned prots to the Treasury since the mid-1930s.The Fed’s monetary policy can also impact what the ederal governmentpays in interest on the public debt. By keeping short-term rates low, the Fedis helping to keep interest payments owed by the ederal government low.By keeping a lid on infation, the Fed has a hand in keeping intermediate- and

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