Tuesday, October 25, 2016

Fed Gone Wacky?

Bloomberg.com had an article last week with a photo of a smiling Janet Yellen which said that the Fed was elated that the inflation rate was rising in the US. On the same day was an article “The Fed Embraces a More Diverse Future” that had several quotes from Fed officials decrying disparate effects of unemployment on minorities. Minneapolis Fed President Neel Kashkari promised to “spend a day in the life of a struggling black family in order to better understand that experience.” The article concluded  

“While the Fed may have no direct ability to do anything about this relationship, it may be less willing to call an overall unemployment rate of 4.5 to 5 percent full employment if it coincides with a black unemployment rate of 8.5 to 9 percent.

I wanted to know more about the explicit goals of the Fed. I found the below words at a Federal Reserve website https://www.federalreserve.gov/faqs/money_12848.htm
The Congress established the statutory objectives for monetary policy--maximum employment, stable prices, and moderate long-term interest rates--in the Federal Reserve Act. In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level. These objectives are generally complementary. However, under circumstances in which the Committee judges that the objectives are not complementary, it follows a balanced approach in promoting them, taking into account the magnitude of the deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.

Wow. Double Wow. The Fed’s explicit job is to control inflation and employment. Yet today’s Fed officials are happy to see more inflation and are not content when they reach their goal of full employment.

Interesting is how cavalier the Fed is departing from its statutory mission. I can see it now. Hey coach I think I would be more popular if I played guard on our football team. But son, you are a quarterback. Come on coach, the linemen are cool guys and I always wanted to hang with the cool guys.

The Fed has no mission and has no ability to affect the composition of unemployment. If they drive the unemployment rate below the usual definition of full employment – they can provide some jobs for those at the lower end of the labor pool. But history shows that such jobs do not last very long. Driving unemployment so low will cause the economy to run fast enough to absorb more workers. But like any engine that runs faster than normal for a while – it will generate frictions that eventually bring it back to normal – if not requiring a new engine! History suggests also that the aftermath of such reckless driving is often the dreaded scourge stagflation wherein both inflation and unemployment rise together. At some point the Fed then has to tighten and cause a recession and even more unemployment. Thus gains are not only temporary but they end up worsening the entire economy.

As for the seemingly perverse joy over a September rise in the inflation rate, this just underscores my point. Yellen has recently been quoted as saying it would be okay for the economy to run hot for a while. I like my coffee hot but she is delusional if she thinks a hot economy is a good thing. Higher inflation and a hot economy won't accomplish anything except to raise and then dash the expectations and lives of those least able to deal with such changes. 

Unfortunately our current Fed has fallen for the liberal line that one should focus on the short-run. Despite relying on nothing more than dreams and drugs, our Fed wants to make people feel happy that it is doing something. But like many do-gooders, the Fed has neither the tools nor the mission. Just because Congress is broken it does not mean the Fed can pull a rabbit out of a hat. Unequal incomes may be a problem but like the QB who wants to be an offensive lineman, the Fed is neither qualified nor licensed to solve this problem. Mrs Yellen -- please just stick to your job description.  

Tuesday, October 18, 2016

Lesson 16: International Investment

Those of you with post-kindergarten training may or may not know that governments keep international trade statistics. Even some of our current presidential candidates know that.  These statistics are found in something called the Balance of Payments Accounts and are found at bea.gov . 

While there are two equally groovy parts to the BOP figures most politicians only know about one part of it, the Current Account. The Current Account is on the top and we wouldn’t expect those people to actually read all the way down to the bottom, right? They are busy people. Also the history of the world and the solar system has emphasized the Current Account so it would be unfair to criticize our politicians for only knowing about the Current Account.

This Current Account is where we publish statistics that have to do with exports and imports of goods and services. We sell Chevys to China and they sell rice and replicas of the Great Wall to us. It’s a cool deal. Some of our political leaders have noticed that our dear country almost always has a deficit in our Current Account. And that burns them. After all – the word “deficit” is not a nice word. If your teacher said you had deficits in your behavior, you would feel injured and probably never get a PhD in science or classical studies. This deficit in Current Account means that we are buying more stuff from other countries than they are buying from us. This is especially true of China and since we have a very long list of other issues with China, our politicians complain and sometimes cry that this deficit with China is worse than Dengue Fever and needs to be stopped.

I have written thousands of posts (I exaggerate all the time) which explain why Current Account deficits are not necessarily bad things and I don’t won’t to repeat all that minutia here. I see the Tuna is already starting to nod off.

This post is about the other part of the BOP Accounts – the part at the bottom that most people ignore. It is the part that our politicians don’t have a clue about. So you should feel very special that I am doing this for you today and send either money or JD to thank me.

The second part of the BOP account is called the Financial and Capital Account (F&C Account). What a name! Can you imagine being in the first grade and having a name like that? No wonder no one looks at this account. But this account is the coolest kid on the block and has a lot to tell us.

The F&C Account records all the financial trades between countries. We don’t usually call these import and exports – instead we talk about outflows and inflows. If China invests in America we call that an investment inflow. We like it when foreigners open up US bank accounts and when they buy our bonds, stocks, and companies. All of those financial inflows are recorded in our F&C Account. At the same time, we also like it when US citizens invest abroad. We usually call that diversification. You don’t want all your eggs in one basket and you don’t want all your investments in US bonds, stocks, etc.

When foreigners invest in America we call that an inflow. When US citizens invest abroad we call that a financial outflow. Globalization means that citizens around the world have become increasingly interested in investments both at home and abroad. 

So as a public service and hopefully for money and booze I will acquaint you with some of the financial flow numbers. Below I will refer to some numbers from a close cousin of the F&C Account called the International Investment Account or IIA (the F&C Account focuses on the one period flows between countries while the IIA reports the resulting total ownership positions). 

As it turns out, there are some looming risks associated with the IIA account that we should be worrying about. Unfortunately our leaders are playing with their bellybuttons and/or are unaware of these trends.

I went to the bea.gov web site and downloaded a spreadsheet of IIA information from 2000 to 2015. Here is some of the information from that download:

                                         2000   2007   2015
US Ownership of F. Assets   7.6    20.7    23.3   
F. Ownership of US Assets   9.2    22.0    30.6
Data is trillions of US dollars
F. stands for Foreign

This little table tells you the following:

·       Globalization of financial markets was very evident in the new century with foreign ownership more than tripling from 2000 to 2015.

·       Most of that increase came between 2000 and 2007.

·       Then the activity slowed – especially with respect to US ownership of foreign assets. After growing by $13.1 trillion in the first period, it grew by $2.6 trillion between 2007 and 2015.

·       Foreign ownership of US assets slowed as well but it still increased by almost $9 trillion between 2007 and 2015.

·       If we focus on the 2007 to 2015 time period we see a much wider gulf – foreigners owned $7.3 trillion more of us than we owned of them. Nearly all of that gap can be explained by what is called portfolio investment (in bonds and stocks). That gap was $1.6 trillion in 2000; $1.3 trillion in 2007; and then $7.3 trillion in 2015.

What’s going on? Why are foreigners so interested in our financial markets?

First, since the financial crisis, the US has done better economically than other countries. A relatively stronger economic profile means more confidence in our financial products. Think Greece, China, and Venezuela.  

Second, think US government deficits and debt that have supplied a lot of investment opportunities to both residents and foreigners. Foreigners gobbled up our huge pile of new government bonds!

Third, while foreign companies did increase their acquiring and merging with in US companies, most of the gap mentioned above came from investments in private bonds, government bonds, and equities.

Fourth, notice that despite the gap, US citizens have shown a strong and growing appetite for foreign bonds and stocks. Despite a financial crisis foreigners continued to buy US assets and Americans continued to buy foreign assets.

What do we make of all this? When the gap is favoring US assets, this implies two important things. First, people need dollars to buy US assets so this has strengthened the dollar. Second, when foreigners buy our assets this pushes our asset prices up and interest rates down. With the huge increases in national debt and the needs of firms to finance their investment projects, this asset demand from foreigners prevented our interest rates from rising/stocks falling and thus helped to keep the US economy growing.  

And this is what concerns me. What happens when things turnaround? What happens when other major countries strengthen and their assets look more desirable to global investors? What happens when our government increases its debt even more as foreigners desert US financial markets? Financial globalization made the US wealthier when the rest of the world was weak and uncertain. Financial globalization will have the opposite impact if the US grows weaker relative to Europe, Japan, China, and other countries. Our politicians have complained loudly about the Current Account Deficit. Just wait to see what happens when buckets of money leave the US to be invested elsewhere. Then we will be clamoring about deficits -- deficits in the F&C Account!  

Tuesday, October 11, 2016

Debt? What Debt?

After the Presidential debates one would have wondered if national debt is in the vocabulary of our two candidates. Surely Donald Trump’s business deals in the 1970s and Hillary’s personal appearance are more important than the national debt. At least those two issues were discussed. But nary a word was uttered about the national debt. 

Each try to outdo each other with policies that would increase the debt but none seemed worried that a larger debt might be a problem. Surely making college free is more important that a nation’s debt. Surely giving families more time off from work is more important than a nation being able to pay off its debts.

So here I go again about debt. Debt is both easy and complicated. It is both beneficial and dangerous. It is seductive like a night with a hooker and debilitating like the rash that follows. And like the drug addict, he or she is the last one to ever admit that he or she is hooked. What a topic!

Debt is easy to understand. Consider three stories.

Story 1. You get to the end of the month and you spent all your cash. Luckily you have a plastic card that lets you buy a few more essentials. Or maybe you buy a few more Miller Lites or a lottery ticket. Next month you conserve a bit and are able to buy all you need and payoff your credit card. In that case, the debt lasts only a month. That story is both simple and nice. Debt was an instrument to accomplish an objective.

Story 2. You want to buy a house or a horse. Or a hose. These items all start with H and all three of them are durable goods. If you take care of them they last a while. It makes sense to pay for them over a time period that is similar to the life of the durable good. So you use credit to buy a durable good and you pay it off over time. That is another simple and acceptable role for debt. If you are a humble employee in the workforce you don’t buy a $4 million dollar house. It is too expensive. It would create too much debt to pay back. Instead you buy a house whose payments are comfortable for your monthly income.

Story 3. You buy that $4 million dollar house. Or maybe you really like JD but you decide to instead buy a new $400 bottle of Pappy. You like the Pappy so much that you buy a bottle a day and a few extra bottles for your friends. Clearly you cannot afford $12,000 per month for bourbon. But it REALLY tastes good. Your mortgage lender or your credit card company likes you to take on more debt. At least until the day comes when you quit paying them.

Story 3 is a silly story, right? But we know that people and countries do this kind of behavior. People go into debt for all sorts of reasons – houses, cars, education, jewelry, gambling, drugs, and more.  Countries get hooked on defense spending, pension programs, healthcare, and more. When I say hooked I am not implying anything negative about spending on any of these items. The problem comes when you spend more than you can afford and you find it difficult to stop.

But what can you afford? That’s an interesting part of all this. Except for the dishonest and corrupt, most of us think we can afford our debt. Like me, many of you bought your first house, looked at the size of the mortgage, and started to shiver and shake. Can I really pay back that amount? I was young then and did not know what would happen to me. But a good financial system has criteria and rules and they are willing to bet on people who have track records and/or whose current situations warrant trust.

This brings to mind two challenges. First, we make mistakes and accidentally take on debt that is too high. Second, unexpected things unfold that change the equations. Worst among these is that you lose your job and/or your future income turns out to be much lower than you expected. Also terrible is that unexpected expenses crop up and eat up your income – healthcare, a family member needs help, your kid gets accepted to Harvard, and so on. Whatever the case, stuff happens and then you can no longer pay the debt.

When you can no longer pay the debt is when things get tough. There is no easy way out. You are between the proverbial rock and hard place. Even if you find a way to not fully repay your creditors, you are back to square one. You have lost the durable good that you can no longer afford. And now, you will find it much more difficult to get new credit – so you will have to live on what you earn. The choices at that point are very unattractive.

Notice that all of this would have been avoided if you had not taken on the debt. Or that you had taken on the debt in a more sustainable way. That leads to unpleasant but rational realities like borrowing much less than the bank will allow. That might mean buying a cheaper house or car or going to IU instead of Harvard but it also means that contingencies are easier to deal with. Another option is to wait. While you wait you save money and later make a good down payment on the durable good. No alternative is foolproof in an uncertain world. But some options reduce the probability of a catastrophe.

Debt is inevitable. Debt can have unforeseen negative and debilitating consequences. So it is good to handle it carefully.

All the above applies to countries too but it gets more complicated. For one thing, having its own currency means that most countries can print money to pay debts. At least for a while. Excessive currency creation we know might work for a while but then it causes inflation and other instabilities that transmit a message to creditors – this ship is taking on water and may sink.  

Think about what happens when a country gets a debt problem. Below I am summarizing some of the things we have learned from debt crises over the years in many different places. The first signs come when the debt gets big enough for people to notice. At that point investors shy away from the debt and that reduces bond prices and raises interest rates in that country. If the debt is not attended to debt rating agencies downgrade the debt causing rates to rise even more. A reduction in purchases of debt by foreigners may cause the currency to depreciate. A rapidly depreciating currency is worrisome and will sometimes cause a country to try to stabilize the downswing. It does this by buying its own currency using foreign reserves – and then the level of those reserves fall. That sends another worrisome signal to the world.

Then the world waits to see if the government gets the point. Everyone knows they have gone into too much debt and need to do something about it. The more the country hesitates to reduce its debt in conventional ways – the more confidence falls, the more interest rates rise, money flows out, the currency depreciates, and foreign reserves plummet.

I am getting depressed. Where is that JD?

What about the US today? Where are we? Actually we are okay. Yes the debt went from roughly 30% of national income to more than twice that in the past decade – and is scheduled to rise even more based on current laws. Some estimates have US debt closing in on about 100% of GDP soon. But that is BEFORE we factor in any of the current proposals by the candidates for more spending and/or less taxes. So maybe we are talking well over 100% by the time the new President gets rolling.

But that’s not the whole story. What happens if we have a crisis? We are due for a recession in the next few years. Given alarming trends in China, Russia, Iran, and Syria might we decide to spend a lot more on defense and security?  Will we need to bail out business and/or student debt? Such scenarios could send our national debt soaring to well above 100% of GDP. Then what will happen? Nothing good! Now is the time to worry about that. Not after the fit hits the shan. 

Tuesday, October 4, 2016

Lesson 15 Money and Monetary Policy

Janet Yellen is the head of the Fed. She and her colleagues at the Fed determine the nation’s money supply. Much has been said about her management of money and lately she is being labelled a lackey of the President and Mrs. Clinton. I doubt she is lackey but I would say that she is guilty of drinking the same Kool-Aid as her liberal progressive buddies in government.

We grew up with Kool-Aid and I don’t mean to disparage that lovely and colorful drink with enough sugar in it to start a diabetic colony.  What I mean is that Yellen, Obama, Clinton and many others share a similar philosophy in general and in particular with respect to the magical qualities of money.

And that’s what makes this post today so much fun. Money itself is about as exciting as your Uncle Ed who rocks himself to sleep at 1 pm in the living room while you watch his cigar ash fall on his partly open bathrobe. Money is paper. Or money is electronic entries that get transferred from one account to another. 

This is not exciting stuff. You buy something – whip out a bill or a debit card – and the deed is done. Nothing to write home about there. It’s like your best friend Peter. You wear plaids and so does he. You wear stripes and so does he.
Although money itself lacks any real excitement, governments can turn it into Charlie Sheen on crack. There was a day when the world did not have money. We called that barter. A farmer would trade three carriage loads of corn for two dresses. That worked okay but corn farmers could not always find dressmakers and so pretty soon money evolved. If everyone carried money it made transactions much simpler.

Money went through a number of stages. Money needed to be around. At first it was commodities – stuff that most people already had and knew the value of – like corn or wheat. Then they were replaced by commodities that seemed to be more durable and held value better – like silver and gold. Silver and gold are pretty but those commodities are heavy or bulky and not easy to safeguard or carry to Sam’s Club. The next stage created paper money  wherein the paper money had to be backed by gold. Paper was essentially valueless but it represented an amount of gold.

Are you history-lovers still awake? Finally came the stage where money could be pulled out of a hat. Not really a hat but essentially the same thing. Central banks create money at will. They need nothing but a magic wand and an Internet connection. Money is “backed” by faith that the central bank will always create the right amount. Not too much and not too little. Like Goldilocks, we like just the right amount of money. The Fed pretends to give us what we want.

And here is where ideology comes in. The conservative school of thought sees the world as being very complicated and uncertain. The right amount of money is no easy thing to attain. Jim suddenly needs money to fix his roof. Dan swears money off when he decides to live in the forest. Imagine figuring out the right amount of money for a whole country day by day. Humbly, conservatives prefer a passive approach. Transactions usually grow by about 5% per year. So let the money supply grow by 5%. End of story. Go fishing.

But liberals always think they know more and apparently they are nervous people who don’t like fishing. They erect giant data collecting machines and try to measure the demand for money on a minute by minute basis. They take great delight and credit by measuring and the ups and downs of money and then trying to match those demand changes with more or less money. Think Whac-a-Mole. Liberals admit that sometimes they get it wrong. They admit that sometimes they even cause recessions when they get it wrong. But alas they are progressives and they are pretty sure that sometime in the future their models will be more correct and the world will be saved. Think Don Quixote.

If the above is not enough to make you reach for the JD pitcher there is more. Even though the infamous JM Keynes said that controlling money was like pushing on a string other modern liberal economists decided to give monetary policy a bigger role in society. Matching money supplied to transactions needs was way too boring for these moderns. So they decided they would match money to employment, prices, exchange rates, and hooker sales. If employment was too low then pump a bunch of money. If prices are too high take it back out. If exchange rates rise then blame China. If hooker sales go up or down call Charlie Sheen.

Talk about a way to guarantee that your name will get into the Bloomington Herald Times on a regular basis. The Fed now has so many balls in the air that it would take a multi-headed hydra to try to catch them all. But undaunted they collect data every day and they have serious discussions and then they go home to their mansions and foreign sports cars.

Yellen and her buddies at the Fed and in the government are not necessarily colluding. They simply have this faith that they know how to manage a 21st century global economy. That they have been doing it badly never concerns them. They never question this faith that more active policy is better. They are modern and smart. They will learn from their mistakes and finally get it right. They will save us.

Their disease is incurable because failure begets more activism and then more failure. Nowhere in their playbook is taking a deep breath. Nowhere in their training is the idea that too much variance and activism creates uncertainty. Nowhere in their discussions is that it takes time to disentangle short-term noise from long-term trends. Nowhere in their arsenal is the knowledge that some problems are non-monetary in nature and require non-monetary solutions. 

Lackey? I don't think so. Misguided and dangerous? I think so. 

Tuesday, September 27, 2016

Ozzie and Harriet would be Mortified

A man and his wife were driving down a curvy mountainous road. The wife was driving.  They were arguing. All of a sudden the man yells out "Pig!" The wife looks at him in disdain and says "Jerk" and then immediately she ran into a large hog crossing the street. 

How many situations are like this? How many times do we go off half-cocked? How many times do we perpetuate arguments and differences of opinion because we fail to consider other viewpoints? Are we really always right and the other people are always wrong? Are there no truths somewhere in between? 

Consider all this in the context of the coming election. The majority of things we read and see today are not involved with anyone trying to convince us as to the best way to move forward in a very complicated world. Much of what we hear is personal attack – Hillary is a liar and a corrupt person. Trump is dumber than the Three Stooges and will immediately start World War III. When I discuss the election with my liberal friends most of them imply that if I vote for Trump I will have willingly sided with the devil. My conservative friends explain that voting for Hillary makes me no longer worthy of salvation. Either way I won't be invited to many parties. 

To me all this seems sad and worrisome. It is sad because it further divides us. We are not debating policy – rather we are making our differences more vivid and rigid. It is worrisome because it promises to continue to prevent us from seeing the world as it really is and trying to fashion remedies for our most challenging problems.

Before you start reminding me of all the evils that the other guys stand for and roasting me over a gumbaya-less campfire, let me explain a little more from where I come. While it is true that the people on the other side of the political aisle see the world differently and say some scary things, let’s try to image what we have in common.

·       We all, except for Charlie the Tuna, are part of the human race.
·       If we have families we want them to be happy and safe.We want our children to enjoy youthful experiences but also to learn responsibility
·       We want access to high quality healthcare that is affordable.
             If we have children we want them to grow up learning and to be prepared for life.
     We don’t want to wear gas masks to work and we want good jobs.  
·       We want to be a positive force in the global economy while recognizing that there always seem to be some countries or parts of countries that want to hurt us.
·       We believe that governments have proper roles in society but the positive outcomes of government are not automatic.
·       We know that governments, business firms, labor unions, and football teams are composed of mostly good people but to some extent they are populated by some really evil and corrupt individuals.  

Some of you are gagging so I will stop. I could go on. And on. And on. But its true. We have many common goals. I know – there is a conspiracy of progressives who want us all to become Communists. I know – there are many conservatives who want to preserve only the fittest and the rest be damned. I don’t disagree. There are some people like that. But what I also know is that most of us just want to get up in the morning, eat our Post Toasties, send our kids to school, go to work, and start planning weekend parties! 

We definitely disagree on the particulars of how to attain the above outcomes. We even disagree about the nature of the human spirit. But come on -- in a country of almost 330 million people, not everyone is going to see things the same way. My way or the highway is not going to work. 

But we can’t make any real headway because more and more of us get processed by the dividers who, by the way, get money and power by continuing to divide us.

We don’t have time to waste. As we hurl insults at each other, Rome burns. How do we deal effectively with ISIS? With other national enemies? National debt? Two-way racism? Economic growth? Crime? Security? and so on?  

Each of the parties will try to convince us that their way is the only way as they use every trick in the book to turn us against their evil competitors. But the evil competitors are mostly just like us. They want to see problems solved and get on with their lives. And worse, as each side slowly creates enemies lists we make it increasingly impossible to see our problems objectively and to find solutions that make any sense. We are on a path to Hell. 

Ozzie and Harriet would be very disappointed in us.

Tuesday, September 20, 2016

Joe Friday: Just the Facts M'am

As we come closer to Election Day in the USA we will hear and read a lot of things about the US economy. The blue team will brag about their victories over incomes, employment, and poverty. The red team will say the economy plods and weaves like a drunk on Kirkwood Avenue at 2 am. As you know I love data and so I decided to play around with some familiar information. It is impossible to summarize all economic data in a small space so I decided to focus on recent changes in real GDP and its components.

I stick to the facts today. I think the facts tell a clear story about slowing economic growth and one that deserves a policy discussion. But that discussion will have to wait. I already used up today's word count. 

GDP is a measure of the nation’s output of goods and services. Real GDP means that we are measuring output in constant prices –meaning that price change is not part of the change in real GDP. If real GDP increases it is totally because output or quantity produced changed. We like to analyze output because it usually has a strong association with things like employment, incomes, and sales of Jack Daniels.

GDP is output. It does not tell you about financial wealth. Of course if we are wealthier we often buy more goods and services but GDP does not directly measure wealth. It does not measure poverty and it does not measure distribution of income.

I wanted to examine near-term changes in real GDP so I did the following. For real GDP and each of its major components I looked at the annualized* percentage change over the past two quarters, past four quarters, and past eight quarters. By doing that I could get an idea as to whether things are improving, worsening, or staying the same.

For example, in the past two quarters real GDP grew by an annualized 1%. That was slower than the 1.2% it grew over the last four quarters and was less than half of the 2.1% annualized rate it grew in the last two years. These calculations suggest that things are clearly worsening. In 2016 the US economy is growing considerably slower than in the past year or two. And by the way – even the 2.1% rate two-year rate is not a strong growth rate for the USA.

Rather than speculate on a lot of causes of this slowdown, I decided to focus today on the components of real GDP. Recall that the Product Account approach to measuring real GDP focuses on the buyers of the output. The standard approach sees four buyers of US produced goods and services – domestic consumers, business firms, (federal, state, and local) governments, and foreign buyers. If real GDP is slowing it is because one or more of these buyers have slowed their purchases of US goods and services.

So I looked at consumers first. Households spent an annualized 4.5% more than two quarters ago on goods and services. Compared to the 1% overall GDP growth number for the past half-year, that’s a very strong rate. Way to go consumers! But even consumer spending has been slowing. Over the past two years it grew by an annualized 6.2%; it grew by 4.8% over the past year; and then 4.5% over the past half year.

Consumers desire for newly-built residences also flamed out. What we call Residential Construction declined by -0.2% in the past two quarters. Residential Construction grew by 5.7% in the past four quarters; by 8.5% over the past two years.

What about business spending? Business firms buy newly produced structures, equipment, and intellectual property. Here the news is ugly. Equipment spending was down by almost -7% in the last two quarters. That was a major decline from the -1.9% in the last year and the 0.7% annual rate of the past two years. Buying of new plant and other business structures shows a slightly different but dismal pattern of contraction. For example, spending on Structures was down by an annualized -4.3% in the past half year; -7.1% in four quarters; down -5.2% annualized in the past eight quarters.  The only positive story for business spending was for intellectual property purchases – growing at about 5% over the past two years.

If you like numbers instead of growth rates – business spending was up by about $30 billion dollars since the second quarter of 2014. During that same time period personal consumer spending was up $674 billion. Business spending on plant and equipment is the main way we expand both productivity and productive capacity. 

US exports are goods and services we sell to foreigners. The story there is not encouraging and falls in line with a slowdown theme -- declining by -0.2%/-1.3% in the last two/one years respectively. Exports leveled with 0.2% growth in the two past quarters.  

Let’s turn to some of the government buying numbers**. There is nothing particularly interesting coming out of federal versus state and local government spending. All government spending has slowed in the past year and past six months. More interesting is the breakdown of federal spending between defense and non-defense. In the past 6 months, defense spending slowed by -3.1% after contracting by -0.8% in the past year and by -1.5% in the past two years. Non-defense spending, in sharp contrast, grew by 2.3% over the past six months; 2.9% over the past year, and 3.3% annualized in the past two years.

I know there are a lot of things to discuss with respect to the economy and national policy. But the recent real GDP figures are very clear.

·       The economy is slowing.

·       The strongest growth sectors have been household spending on goods, services, and houses, – though even that strong growth is declining over the past two years.

·       Also contributing to positive economic growth was non-defense federal government spending on goods and services.

·       The weakest sectors showing significant contractions are business spending on plant and equipment and defense spending.

*All the figures in this post have been annualized. Whenever you compare different time periods you need to find a way to make them comparable. By annualizing, for example a half-year change, you are calculating how much real GDP would have grown in four quarters if it continued at the same pace as over the two quarters. When you annualize a two year change – you are showing how much it grew, on average, per year. 

** The government figures quoted here reflect only government purchases of goods and services. Much of what the government spends is for transfers and net interest. That information is found in the government budgeting figures but are not a direct part of the components of GDP. 

Tuesday, September 13, 2016

Happy Trails or Fearthquake 2?

This is dangerous. It is Saturday and the time I usually begin the drafting of Tuesday’s blog post. The financial markets will open and close on Monday before I post my usual dribble. Common sense would argue to let the experts stick their necks out and say stupid things that turn out to be wrong. I could instead write about Donald’s ties or Hillary’s latest pantsuit. But no, I decided to join the fray. Don’t ever say that economists don’t live life on the edge. Please note the dripping sarcasm.

Anyway if you have a television or a cell phone, you know that financial markets did a crazy dance on Friday. The main market indexes closed 2% down and US interest rates rose. I am guessing that in some places gravity pulled things up and sinners read Bibles. It was quite a day.

Those of us who were alive and over the age of seven in 2008 remember a similar decline in the markets. In that case one decline led to another and it wasn’t long before billionaires were removing zeroes from their wealth numbers. So if people are a little crazy this week it is because they have personally seen the fearthquake’s ability to turn everything upsidedown. See last week’s post if you don’t know the word fearthquake.

Many of us are beginning the football season unsure of what to bring to the tailgate. Should we bring expensive bourbon or PBR? Was Friday a false signal? Was Friday an exaggeration? Or was Friday the beginning of hell?

I am guessing that Friday was an exaggeration. Mom, that truck is going to hit us. No it isn’t. Yes it is. No it isn’t. Well, it isn’t really a truck. It’s a toy truck.

In my stupid example the truck is a metaphor for rising interest rates. On Friday we saw what happens when more and more people became surer that a truck is going to hit them. Fed officials said this. The ECB said that. Japan said so and so. All that information helped people become more sure that interest rates are going to rise and stocks plummeted.

I don’t question any of that. But what we collectively are not sure of right now is how big the truck is. A truck is coming but how devastating will be the resulting collision?
One view is held by the naïve mathematicians. Naïve means a strong belief in mean-reverting behavior. Suppose you averaged 180 pounds for most of your life and you get ill and lose 20 pounds. A mean-reverting forecast would have you gaining 20 pounds and going back to your normal weight. If an interest rate had an average of 5% and is now 2%, then a similar approach would believe the interest rate is headed back to 5%.

Mean reverting forecasts make a lot of sense. But notice they are based on an “everything else is the same” assumption. You dropped weight because of illness. When the illness departs you gain back the weight… if everything else is the same – your eating is the same, your exercise is the same, and you still have most of your teeth.

But mean-reverting behavior makes less sense if much has changed. With respect to interest rates, has anything changed? It depends on who you talk to or read. My Republican friends would tell me that Obama has destroyed the US economy. As such capital is worth less, the economy will grow slower, and the trust in bonds has diminished. Furthermore demand, like the final third of a cheap cigar, is harder to draw and is leading to permanently lower inflation. My Democrat friends would point to the negative impacts of income redistribution, globalization, and deplorable Republicans in harming economic growth, demand, and inflation.

If these lovely people are correct, then the usual pressures that would produce a return to a 5% interest rate (from the example above) are missing in action.  That means that the changed economic reality of today and tomorrow does not imply a return to any specific higher interest rate. Surely rates will rise but will they rise by 1%, 2%, 3% or more?

These are some of the questions discussed at our Saturday tailgates. Surely our favorite teams will win by many touchdowns and the deviled eggs will be delightful and make the JD go down ever so nicely. But don’t expect that these questions will be resolved on Monday (yesterday) or today. Get your seat belt on for another good ride. Or maybe they will be resolved and today will return to unicorns and methane-free cows. 

I am guessing that the bucking will go for a while but when the dust is settled we will be back on our slow-growth economy with nervous stock prices and interest rates. Interest rates will rise but ever-so-slowly. 

I’ll end this with the lovely words that Roy used to sing to Dale,

Some trails are happy ones,
Others are blue.
It's the way you ride the trail that counts,
Here's a happy one for you.
Happy trails to you,
Until we meet again.
Happy trails to you,
Keep smiling until then.
Who cares about the clouds when we're together?
Just sing a song, and bring the sunny weather.
Happy trails to you,
Until we meet again.

Tuesday, September 6, 2016

The Fed, Fitbit and Fearthquakes

Can you weigh yourself too often? Most of us are concerned about our weight. Being too heavy or fat is not what we strive for and in many cases we ought to be concerned for health reasons. As such, measuring one’s weight or girth is not a bad idea. The question then is how best to measure.

The measure I prefer is how my clothes feel. I cannot fool my Levis. When I gain weight they scream at me. Another approach is to buy a nice scale and stand on it now and then. I approximate that once a year when my blankety-blank doctor insists on knowing how much I weigh at my annual physical. To add insult to injury he makes me wear my shoes on the scale. Others think it sensible to detect trends and to weigh oneself at least once a month. My Fitbit friends are at the extreme. They measure every second.

And that’s where I part company. And that’s where I also get to today’s topic, the Fed. The Fed thinks it needs to read the pulse of the nation every minute. As if these frequent measurements will help them manage the US economy better. Think of your weight again. Body weight is partly mystery. You and I have both gone on radical diets that lasted at least 12 hours. And guess what? The stupid scale said we gained weight. And even if weight was a little more understandable and we did lose 0.5 pounds in 12 hours or 12 days – what then would that tell us? Way to go dude. Go eat a big buffalo burger.

Good monetary policy ought to be like a good diet. It works because you apply a new sensible regime over a long period of time. Or maybe it is more like a steamroller. If the road gets bumpy then flatten it out. Don’t take a hammer and flatten each and every bump as it arrives.  Ms. Yellen’s Fitbit contains an intermittent flow of hundreds of pieces of relevant but often conflicting information on a daily basis. It has her mesmerized. As recently as last week she was still not convinced that the US economy was growing fast enough. Let’s take in a little more data today. Maybe tomorrow she will be convinced. Or maybe not.

Meanwhile what is the problem? Why can’t we just lumber along? We aren’t growing very fast but we are growing faster than most other countries. Shouldn’t we be happy and proud about that? And inflation is not a problem. Give Ms Yellen a break. This line of argument shows how successful she, her buddies at the Fed, folks in government, and the press have been about hiding the elephant in the shop. It amazes me that except for an article here and there in some business tabloids, everyone is silent about something called imbalances.

Imbalances is not a great word. It doesn’t shout “save me” in the same way that recession or rich persons or automatic rifle does. Maybe I should make up a new word. Let’s call it a Fearthquake. F has nothing to do with methane this week. F means financial. Earthquake means well earthquake. They had an earthquake in Italy recently. We know earthquakes are terrifying events. A Fearthquake is just as bad. We had a Fearthquake in 2007. We are still suffering from the aftershocks.

That Fearthquake and the looming next one come from imbalances. In the case of 2007, the imbalances were in the housing and equity markets. Maybe that is why we are so reluctant to name this evil. Many of us were enjoying price appreciate in our homes and stocks. No one wanted to rain on that parade. But the Fed learned nothing from that episode. It is totally obvious that keeping interest rates low to negative for almost a decade is causing the economy to walk slowly and with a limp. Saving makes no sense in this economy. 

One wonders why productivity is so slow. Has there ever been an economy in the world that had strong perpetual growth in productivity and output with such little saving? And risk tolerance. I am not a finance expert but corner one if you get a chance. Because of low interest rates households are moving into bonds instead of money; into risky bonds instead of low risk bonds; into equities instead of bonds, and so on. And firms are doing the same things. Government believes they can borrow more and more – and a rising national debt will have no negative consequences. They back student loans as if these loans will ever be paid back. Please tell me Ms Yellen why you don't talk about any of these imbalances and the coming Fearthquake?

Call it imbalances or a Fearthquake. Ms Yellen needs to trash her economic Fitbit and put on her jeans. Maybe they will convince her that something bad is coming. It might not be too late for a return to sane monetary policy. 

Tuesday, August 30, 2016

Lesson 14: GDP Complaints and Super-Heroes

How are you doing? Excellent! Well, not exactly excellent. I feel great but my lower back is tight and my eyeballs are a little itchy. Okay my knee aches a little and my allergies have been flaring up.

Why don’t we have one single measure for how we are going? If we had such a single measure I could answer the above question with something like – my PSHM (personal single health measure) is up 15% this year. In August alone it rose by 15 points. Now that would be cool. But as you are questioning my sobriety right now – the point is well-taken when it comes to health. Health is highly multidimensional. We don’t really want a single measure of health. Nor do we want a single measure of how much fun you had last weekend. We clearly don’t want one indicator of how nice you are.

Then why in the world are people discussing the development of a new economic indicator to replace GDP? I see these articles all the time. The WSJ had such an article last week lamenting that GDP is too slim and there is so much going on around it. They mentioned how GDP tells you nothing about the distribution of income. It also is silent when it comes to investment versus consumer spending in China. It also says absolutely nothing about cow methane in Texas. (Betty says I can’t use four letter words starting with an F; thus methane).

I have heard similar statements since I started teaching macro in 1910. Critics lament that GDP is not a good measure of a nation’s overall welfare or happiness. They search for the Holy Grail of macro indicators. So with that as an introduction, let’s talk about GDP – what’s right with it and what could be improved.

Gross Domestic Product can be defined with one word – output. It is the output of a country where output is defined as the total amount of goods and services produced. The GDP for 2015 of about $18 trillion is the value of all goods and services produced in the 12 months of 2015. If a tall toilet got produced in 2015, it would be counted in GDP of 2015 – even if it didn’t get sold until yesterday. So be clear – GDP is not sales. GDP is output.

When we listen to complaints about GDP – keep in mind that it is pretty good at what it does – measuring national output. It is not supposed to be a measure of welfare or a measure of happiness. It’s output plain and simple.

A second issue has to do with laziness. While GDP is one number that gets publicized widely each quarter, the calculation of GDP involves at least two techniques and a large number of indicators. One approach (the Product Account) asks what happens after the stuff is produced. Some of it does not get sold and goes into inventories. The rest of it is sold to consumers, firms, governments, foreigners, etc. You can find and analyze all those details if you take the time and effort. 

A second approach (The Income Account) measures output in terms of what the factors earned/contributed in producing it.  So if you take a little extra time  you can learn how much of the output came from labor, ownership, and from barnyard animals. You could go blind reading all those details—there are so many of them published EVERY quarter. But you miss most of that detail because it is pretty boring to the press.

Is GDP perfect? Is Superwoman perfect? Of course not.  Superwoman often enlists the help of other super heroes to subdue evil. And even Superwoman has a bad hair day now and then. Even with all the details I mentioned above, GDP has two important limitations. 

First, it simply is not a good measure of welfare or happiness or distribution of income. Second, even as a measure of output, as the structure of the economy changes over time, so must GDP. Notice how over the years we have moved from producing mostly agriculture, to manufacturing, to services, to high tech, and even to pizza delivered by drones. To get the output number right, our methods of collection and estimation have to change. And that is why the Bureau of Economic Analysis has more economists than rats have fleas. 

So we continually try to improve GDP as a measure of output. And we also continue to develop measures of other important facets of economic health. If we are interested in distribution of income, the Census Department has a lot of data we can examine. If we are interested in welfare, then we know that economists have developed a number of measures exactly for that purpose. As for happiness, I know some monks you might refer to. 

The trouble with these broader measures is lack of consensus driven by varying definitions of somewhat hazy concepts like distribution of income, welfare, and happiness. We should keep trying to widen our scope of published super-statistics but keep in mind that all that activity has little to do with the usefulness and perfection of GDP, the nation's output of goods and services.

Tuesday, August 23, 2016

Free Trade and Burpees

I’m bothered that people don’t see trade the same way I do. Despite the fact that trade is highly multidimensional, people still focus on just one part – the trade deficit in goods. The trade deficit in goods is the telling figure to most people. We import more goods than we export. So there must be something wrong with us. Furthermore they equate years of decline in manufacturing employment with this surplus of imports. It sounds simple. We buy stuff from China instead of America and therefore we have a trade deficit and employment contracts in the USA.

But simple things are sometimes not so simple.

First, an analogy. Ashley tells Jason he should exercise more. It’s good for you, she says. So Jason starts a new exercise routine. Hey Ashley he says, my arms and legs hurt. They are killing me. Keep exercising she says, it will help your whole body. You will thank me later.

The pains of free trade are quick and obvious. To those displaced or diminished, their plights are not to be minimized or ignored. They must be assisted. But that is an issue separate from whether or not we should incur the pain. Some people say, no pain no gain. Maybe that is extreme. But ask any Olympic athlete and they can tell you how many hours and Ibuprofen it took to master their sport. Ask any musician how easy it was to learn how to make nice music.

With international trade we see the obvious hardships the nation must incur today. But the benefits are gradual in coming, diffused and much more difficult to see. Exercise does not make you jump 17 feet over a bar today – but it does help you be stronger and more flexible as you age.

Still, you might wonder whether the US benefits from trade. Consider this. Our population is 324 million people. The world’s population is 7.4 billion. There are lot of wants and needs residing outside of the US. And those  needs are growing. World per capital income (according to the World Bank) rose from $500 per person in 1960 to $10,000 in 2015. 

The average American made more than 5 times what the average world citizen made in 2015. World GDP rose by $72 trillion from 1960 to 2015. In comparison, US GDP rose by less than $18 trillion. POINT – the rest of the world has a lot of catching up to reach the US standard of living – and as they do their incomes will rise by huge amounts. They may not be there yet, but we definitely want to position ourselves to take advantage of rising world wealth. Being hostile to foreign business is not a great way to do that.

Finally let’s look at some trade data. Today I focus on the real values of goods exports and imports. This leaves out services because they are in surplus. These measures also eliminate prices and focus on the quantity of goods coming in and out of the country. I looked at the annual data since 1967. The numbers are percentage changes. Data can be found at bea.gov.

·       Of the 48 years between 1967 and 2015, in 22 of those years US exports grew faster than imports. In 26 years imports grew faster exports.

·       Goods imports annual percentage change exceeded goods exports sporadically (1968, 1969, 1971, 1972, 1976, 1977), from 1981 to 1986,  from 1992 to 1994, 1996, and 1998 to 2004, 2010, 2014, 2015.

·       In all the remaining years, exports of goods annual percentage change exceeded import change. More recently exports growth from the US exceeded import growth from 2005 to through 2013.

·       This is not the picture of a uniformly declining competitiveness of the USA because of globalization. In fact 12 of the 26 years when imports were rising faster than exports were before globalization picked up in the early 1990s.

·       In 2004 exports of goods trailed imports – with exports just over 50% of the value of all imports. By 2013 the ratio had increased to about 70%.

It is true that the US has a large goods trade deficit with the rest of world and especially with China. It is also true that this deficit has widened in value terms. But if we focus on real values we see a comeback with exports of goods growing faster than imports. This in no way proves that all is good and fair in international trade. But as the world regains its momentum and the rest of the world stabilizes and begins to catch up with US growth, we should expect them to want even more US goods. Shutting their goods out of US markets will do little to promote their desires to buy from the US.  One more point. 

We should expect that many countries would become stronger competitors to the US once they recovered from World War II damages. We should expect as well that many countries would compete against the US after the massive reforms that occurred worldwide after the collapse of the Soviet Union and dictatorships in South America. We can’t stop any of that and it would silly to try to do so. This tsunami of competition would have occurred with or without free trade agreements. We can argue about unfair trade but the truth is that America is being tested. We can complain about the competitors or we can get busy in figuring out the best way to remain strong in this new world. Withdrawing from the global stage seems counterproductive.

Tuesday, August 16, 2016

The Infrastructure Scam

More Infrastructure is the new hot phrase. Hillary wants it. Trump wants it. Your local asphalt company wants it.  I think maybe even the Pope wants it. All together now – three cheers for more infrastructure.

More infrastructure will cure our ills. More infrastructure will improve productivity, wages, employment, and economic growth. More infrastructure may even shrink your horribly swollen prostate. Sorry kids – this is an adult blog.

From the above words you are ready for the punchline. Surely there can’t be anything wrong with this new focus on more infrastructure. Or can there be?

Notice that more infrastructure spending mostly means spending more on our existing infrastructure. Most discussions mention dilapidated bridges, pot holes in highways, and leaky water systems. We can add sagging power lines and possibly an inefficient network of information technology equipment.  

When we refer to infrastructure we are legitimately singling out another dimension in the list of factors that produce output in a country. We know that how much output we get depends on how much input we use. Labor and capital are the two traditional labels for organizing our thinking about the inputs we use to alter the amount we produce. Now we are emphasizing a third factor – infrastructure.

Imagine a manufacturing company that produces those lovely little outfits worn by female beach volleyball players. That company has sewing machines (capital) and it has workers (labor). But notice that even the tiniest of these garments has to be shipped via truck or airplane. Orders might come in from the Internet. While having capable workers and great sewing machines is important to Tiny Garments, Inc, so is the quality of roads, airports, and computer networks.

The basic theory of infrastructure is not being questioned by me today. It is pretty clear why more and better infrastructure would be better for companies and therefore for their customers. I am not doubting the need for improvements in infrastructure. I am doubting the magnitude of the impacts of the current proposals. 

The questions I have are practical. For one thing, we are not talking about Tiny Garments Inc deciding on the best machines to create their very tiny garments. We are instead talking about society ordering improved roads for all the companies of America. Wow. Can you imagine the mess when the studly representatives of Wyoming get into a duel over whether they need the highway improvements more than brainy Connecticut. Or when kindergartners stage rallies demanding an equal share of the new fiber being laid for the purpose of America’s productivity.  There is only so much we can spend on infrastructure though listening to our main candidates suggests that the sky is the limit.

Which brings me to the next point – what is the optimal amount to spend on infrastructure if our goal is to increase America productivity, wages, and employment? Can you imagine Paul Krugman and Rush Limbaugh coming to some consensus about that. Surely we don’t want too much or too little? After all we have a pretty big national debt and infrastructure won't come cheaply, right?

Once we know how much we want, there is this question about whether or not more infrastructure today will really work to raise productivity, employment, and wages. Remember that this is 2016 and not 1956. In 1956 Eisenhower was President, manufacturing was dominant, and I had a full head of black hair with a pompadour. Putting in a new highway system was a lump sum investment and probably was worth every penny we spent on it after 1956. But in 2016 will another $300 billion or more have similar impacts? I know I have a few black hairs among the few hairs that populate my head and I know Eisenhower is no longer President.

I also know that trucks are already very efficient even on crappy roads and that drones are elbowing their way into delivery. Will $300 billion worth of better roads really make today's workers more valuable to companies? How much better will companies be able to compete because of the better roads? How much will they lower prices because of these efficiencies? How much will our spending and employment increase as a result of these price reductions?

And hold on – is it not possible that in today’s globally competitive high technology environment that some firms may react to improvements in infrastructure by using even less labor? Recall that some equipment is called labor-saving equipment. Some machines replace labor. Is it not possible that infrastructure improvements will mean a smaller demand for labor and lower wages? If infrastructure spending switches from roadways to super IT highways, might we need fewer workers?

I know we don’t expect our politicians to actually think about the things they say. But as I see it, this More Infrastructure thing is more complicated than they explain. It is clearly not a slam dunk no matter what they legislate. But that puts the cart before the donkey. What will they really legislate? Is this a serious attempt to improve economic growth or just another backdoor scam that appears to look like they are doing something? Or are we getting agreement from both parties because a new investment in infrastructure is rife with opportunities for rewarding friends and gaining from corruption?