China and price controls

When will we learn? China announced earlier this month that they would impose price controls on commodity prices and provide some subsidies to stem their increasing inflation. Inflation has moved to 4.4 percent most on the back of higher food and energy costs. The inflation rate is up only 1.3 percent when food and energy are taken out of the equation.

There has been a clear price shock on food and this has a greater impact on living standards for poorer countries that spend that spend more income on food. However, the textbook response to price controls is clear. There will be shortages and hoarding. This is less likely in a controlled economy but it will still occur. There is a clear reason for why food exports to China have increased.

TIPS and negative yields

TIPS yield have turned negative for about a month. With the expectations of QE2 flooding the market, 5-year TIPS yields now post a negative -.23. You get a 50 bps coupon on the 5-year TIP, but you have to pay a price of 103-05 which means that you will pay the Treasury to hold your money for 5-years.

We know that TIP yields are tied to inflationary expectations. 5-year yields are at 1.51 percent so implied inflation rates are now set at 1.74 percent which is lose to the target rate for inflation at 2%. There does not seem to be a threat of inflation. Nominal yields are so low that you expect to lose on the real returns for these assets. Isn't this what the Fed wants? At negative yields, you will not want to save or hold these safe assets. You will want to buy riskier assets at higher yields or spend the money.

This is a perfect environment for investors to chase yields and create a bubble in riskier assets.

The not so funny comedy of rating agencies and US debt

Dagong Global Credit Rating Co. — the Chinese rating agency downgraded the US from AA to A+

The serious defects in the United States economic development and management model will lead to the long-term recession of its national economy, fundamentally lowering the national solvency. The new round of quantitative easing monetary policy adopted by the Federal Reserve has brought about an obvious trend of depreciation of the U.S. dollar, and the continuation and deepening of credit crisis in the U.S. Such a move entirely encroaches on the interests of the creditors, indicating the decline of the U.S. government’s intention of debt repayment. Analysis shows that the crisis confronting the U.S. cannot be ultimately resolved through currency depreciation. On the contrary, it is likely that an overall crisis might be triggered by the U.S. government’s policy to continuously depreciate the U.S. dollar against the will of creditors.

Ouch. This certainly is a slap at US financial debt management. Where the Fed is not buying Treasuries, (the long-end of the yield curve) there has seen a clear change in trend from the summer with long bond yields up over 40 bps in the last month.

So where are the US rating agencies which have the US at triple-A on this issue?