Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

Mr. Chairman, the Eleventh District economy remains strong and continues to grow at a stronger pace than the rest of the country, with employment growth continuing at roughly twice the nation’s pace. Incidentally, home sales have not turned down in our District, so we haven’t been singing yet what we call the “coastal blues” as far as the homebuilding market is concerned. I think that’s enough said about Texas and the Eleventh District.

I would like to talk about what I have learned this time from my usual soundings of some two dozen CEOs and CFOs. I have added a new one, by the way—the largest truck dealer in the country, which does $2.8 billion in sales of heavy trucks. Just as a footnote, what is driving some of what President Poole reported are the changes in emission standards that are being enforced as of January; other than that, they do not see much turndown in volume.

To summarize the reports of these interlocutors, I am going to borrow from Mark Twain’s great quip about the music of Wagner. According to these business contacts, the outlook for economic growth is better than it sounds, whereas the dynamic of inflation is worse than it sounds.

Just a few anecdotes here for, if not similitude, verisimilitude. By the way, all the interlocutors are fully aware of the shape of the yield curve—these individuals are sophisticated— and they are especially aware of what is happening in the housing market. As one CEO told me, the only subject that has been more analyzed than the housing situation is the birth of Brad Pitt’s baby. [Laughter] According to this view, if we have not discounted what has been happening in the housing market, we have been living on Mars, and I think that is an important point to take into account. If you remember, Dave, I have been more pessimistic than the staff in terms of the depth of the housing downturn.

Well, very quickly, according to the CFO of Frito-Lay, he and his counterpart CFOs in consumer goods companies do not see an appreciable slowing of growth from the second quarter to the third quarter. The CFO of UPS reports that, while business is tougher, third-quarter growth is running at a rate of 3 percent, the same as the second quarter, and their business projections indicate GDP growth “in the high 2 percent or low 3 percent area” for the rest of the year. The CEO of Burlington Northern Santa Fe reports that, despite a 17 percent year-over-year falloff in lumber shipments through last week, business overall “has actually firmed since the second quarter.” From my usual report on the Panamax shipping charter rates, it is noteworthy that since our last meeting, when the round-trip booking rate was $23,000 a day, the rate has soared to $31,000 a day. By the way, the rates for carrying back finished products like steel from China, in the so-called handymax fleet, has risen to $27,300 from $23,000 a day, where it was at our last meeting.

All the retailers I talked to—from 7-Eleven to JCPenney to Costco to Home Depot—report that they feel that they have bottomed out and that things are picking up, with one exception. That exception is Wal-Mart, and I think some of that situation relates to the internal dynamics of the way Wal-Mart is positioning itself in the market. I think Bill’s report was very accurate on Wal-Mart.

There are some tempering contra-indicators. The book-to-bill ratio for Texas Instruments and other semiconductor firms has fallen to 1 or slightly below, and advanced bookings for airlines are somewhat weaker. Herb Kelleher of Southwest Airlines, who has to be the most entertaining interlocutor I talk to, tempered that by saying when we met last time the advanced booking curve “index” was, say, 100. It has now eased to somewhere around 95—a noticeable but not dramatic drop.

The CEO of EDS summarized the growth side of the economy much as did the majority of the CEOs I spoke to for this go-round when he said, “We were all expecting things to be worse. They haven’t gotten worse.” They were all expecting things to get tougher, and they haven’t gotten tougher, except for one area—the procurement of labor. There is a shortage of bank tellers and mechanics. By the way, a wrench bender, as they call the job in California now—a simple mechanic without the completion of a high-school diploma—gets $100,000 a year. There is a shortage of truck drivers, of oil field hands, of chemical engineers, and even of unskilled workers such as retail store cashiers in Houston; and for the first time I have heard from the major hoteliers of a shortage of hotel maids. To illustrate the point, one CEO mentioned that, whereas his company regularly used to get 300 applications for 100 truck driver jobs, they now get 3. So the bottom line is that our contacts are feeling more optimistic than the economists’ forecasts. They are worried about some constraints on domestic labor. As one contact said, the economy feels like a full employment economy.

I want to spend just a minute on the inflation picture. I’m not going to go through anecdotes from the CEOs, though it pains me greatly as the son of an Australian to note that Anheuser-Busch has told its retailers that it is going to raise the price of beer 3 percent starting in January 2007. But I do want to explain why our board voted 7 to 1 to raise the discount rate. As you know, we measure inflation at the Dallas Fed by the trimmed mean. Our numbers show trimmed mean inflation running at 3.1 percent in July and a twelve-month rate of 2.7 percent and, not unimportantly, with 57 percent of the component elements increased at a rate of 3 percent or more. Now, of course, we cannot update those numbers until the next PCE number comes out, so you might argue that they are very stale. But the recent CPI release was not comforting. Dave, you mentioned 0.2 percent. Taking that at face value, you can say that consumer inflation is unchanged from July. But if you really look at those numbers, the rate for July was 0.19 percent, and the rate for August was 0.24 percent. If you annualize those numbers, that is a difference between 2.36 percent and 2.9 percent.

So we need to keep in mind that the August CPI reading is about midway between July’s low reading and the elevated readings over the previous four months. At an annual rate of roughly 3 percent, it is better than earlier this year, but it is still uncomfortable. I take President Moskow’s point about our credibility, particularly against the background of the trimmed mean, Cleveland’s median rate of 3.4 percent, and then our six-month trimmed mean rate running at about 2.9 percent, I believe. I mention this simply to urge the Committee that—not only in our deeds, to take President Moskow’s point, but also in our words—we need to continue engendering confidence about inflation expectations and be very careful in the way we state ourselves. We cannot take it for granted that inflation has been completely conquered. Thank you, Mr. Chairman.

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