If anyone doubts that there was a sea change in overall economic conditions from the summer, one only has to look at the recently released report on producer prices. The overall producer price index for finished goods (PPI-FG) fell 2.8% in October, which was much more that consensus expectations.
Stripping out food and energy, core PPI-FG was up 0.4%. On a year-over-year basis, the overall index was up 5.2%. However, as recently at July, this was running at 9.8%. The plunge in energy prices is the prime reason for the decline, with finished energy prices down 12.8% for the month.
The change in the tone of prices is even more dramatic when one looks further up the food chain. For intermediate goods (PPI-IG), prices were down 3.9% for the month, but are still up 10.2% on a year-over-year basis. The PPI-IG peaked on a year-over-year basis in August at 16.7%.
For crude goods (PPI-CG) prices plunged 18.6% on the month, and are now down 1.4% on a year-over-year basis. It had peaked on a year-over-year basis in July at an astounding 51.2%.
Put simply, right now the big problem that the Fed faces is deflation, not inflation. Deleveraging is almost synonymous with deflation. Given fractional reserve banking, when the system deleverages, lots of money simply goes to money heaven.
Under normal circumstances, one would say that PPI numbers like these would be a bright green light for the Fed to cut rates. The problem is that the Fed has already cut almost as far as it can. The target level of Fed funds is already down to 1.0%, matching its lowest level since the 1950's, and the effective Fed funds rate is down well under 50 basis points.
The Fed will most likely cut rates again at its final meeting in December. However, it will not really accomplish much by doing so, especially considering that the effective Fed funds rate is already well below the advertised target rate. The Fed only has four 25 basis point bullets left in its gun, and might use two of them. It cannot, however, bring Fed funds down below zero. Right now the Fed is pushing on a string.
Monetary policy has reached the limits of its effectiveness. Fiscal policy is now the tool needed to lift the economy out of its downward spiral. Now is not the time to worry about budget deficits. Consumers are not spending, and businesses are not investing; net exports have been helping the overall economy, but looking forward it looks unlikely that will continue as the rest of the world slides into the economic abyss.
The economy is operating well below potential. Government spending is the only hope. Look for major spending on infrastructure in the new administration as a way to jump-start the economy. Some of the beneficiaries of this would be the big engineering firms like Fluor Corporation (FLR) and Jacobs Engineering, Inc. (JEC).
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