Bernanke gets it wrong again

On August 22nd, Fed Chairman Bernanke said that he supports analysts' expectations that he will leave rates unchanged despite his acknowledged "jump" in inflation to a 17-year high (as measured by the CPI - consumer price index). The Fed must enforce price stability along with helping the economy. Bernanke is afraid that if he increases rates in order to stop inflation he will hurt the currently weak economy.

But is the economy really weak? Recent news suggests otherwise:

• On August 27th, the Commerce Department reported a gain of 1.3% in orders for durable goods during July after analysts had predicted a decline of 0.4%. They also revised June orders to an increase of 1.3% after previously saying that June order went up by only 0.8%.
  
• On August 28th, the Commerce Department said that 2nd quarter GDP rose by 3.3% after originally saying that the it went up only 1.9%.

The only problem in the economy seems to be unemployment. The unemployment rate is still low at only 5.7%, but unemployed workers are taking longer than usual to find new jobs. The last two weeks saw new unemployment claims decreasing but continuing claims are still relatively high. The bathtub is filling up slower now than a few weeks ago and the water is actually going down the drain. But the drain is partly clogged.

Weakness in other industrial countries have helped increase the value of the dollar and given Bernanke time to wait before increasing rates. The U.S. Dollar has increased almost 8% since President Bush dropped the Federal rule preventing off-shore drilling for crude oil (Congress must pass a bill allowing drilling before off-shore drilling can begin). On August 14th, the European Union's statistics agency said that Euro zone GDP contracted by 0.8% at an annual rate during the 2nd quarter. In Britain, retail sales fell 0.9% in July and manufacturing output is off 1.3% this year. The U.S. growth of 3.3% stands in stark contrast to Europe's economic difficulties.

The Economy and Stocks: Under the Covers a Broad Rally

In July, the S&P 500 lost 0.7% while GDP for the second quarter improved to an annualized gain of 1.9%.

Only six of twenty-five major market sectors went down in July. This was a big change from June when twenty-two of the twenty-five sectors were in the red. Major losses by only two sectors - insurance (-28%) and energy (-34%) - could explain the stock market's July losses. But most of the market gained in July.

Last year, GDP growth was much higher at approximately 4%. The second quarter's 1.9% performance looks lack-luster by comparison. Job market weakness and an increase of more than a point to 5.7% in the unemployment rate has lead many to be fearful of a recession. But these two items point to underlying economic strength:

• June factory orders increased by 1.7% compared to a revised increase of 0.9% in May. Economists had expected only a 0.7% increase for June.
  
• Productivity increased strongly during 2008 at an average rate of 2.5% annually. By contrast, the average productivity rate during the six U.S. recessions since 1970 averaged only 0.8%.

The U.S. economy is recovering from the single quarter of mild contraction (only -0.2%) during the fourth quarter of 2007. Job market weakness is always one of the last to improve during an economic trough.