Monday, May 31, 2010

A Wolf in Sheep's Clothing

Martin Wolf is one of the better print journalists writing today. I see his articles in the Financial Times – the salmon-colored daily newspaper out of London. He must have been really inspired because he wrote back to back articles on May 28 and May 29. Both articles are well-written and thoughtful. Together they illustrate a very broad range of policy choices available for today’s challenges. They also reflect a very soothing (the sheep) but potentially dangerous (the wolf) potion offered by modern day Keynesians.
In Friday’s article ( ) Wolf takes issue with the OECD’s current policy advice that countries soon begin fiscal consolidation and monetary tightening. Wolf appears to agree with the OECD but then wavers on the fiscal suggestion with respect to the UK. He likes the idea for the long-term but frets that engaging too soon would threaten the recovery. He suggests waiting until “recovery is assured.” Wolf then goes on to suggest that in the context of a fiscal consolidation, a loose monetary policy might not be effective. He says with respect to tighter money, “Why the OECD makes this recommendation is beyond me.” The upshot of his article is to control government borrowing but not too quickly. I am not sure what he is recommending about monetary policy since he seems to not prefer monetary expansion or contraction.
Wolf’s Saturday article ( scares the crap out of a fictional boy named Bobby using the idea that economic aftershocks are inevitable and will contribute to an unstable world economy. These aftershocks are the natural aftermath, according to Wolf, of excessive private and government borrowing. Combining this bad news with problems in transforming nations, China’s bubbles, and instabilities on the Korean Peninsula, Wolf concludes with this advice to Bobby, “It is going to be miserable. But you can learn Chinese and go east.”
Wow, I wonder what Wolf had for dinner Friday night! On Friday he was very unhappy with the OECD’s conservative policy advice but willing to consider a way out of the woods. On Saturday he seemed to indicate that developed countries don’t stand much of a chance. He recommends that we move to China. What’s up?
What’s up is what I have been saying for months – but I am not nearly as pessimistic as Wolf (before you call me a simplistic optimistic, please read the final line of this diatribe). The Whack-a-mole economy is a reality. Call it after-shocks or whack-a-mole – the story is the same. We went on a spending binge and now – now when we are at our weakest – the bill is coming due. While this situation is no cause for celebration, it is also not a reason to tell Bobby to pull up stakes and move to China.
Wolf’s problem is no different from the indigestion and confusion of other Keynesians. They live in a world of tradeoffs and zero-sum-games. They live in a world of seeming short-run political realities that offer only palliatives and no means to deal directly with real fundamental problems. The fundamentals are simple. People in the US spend and borrow too much. The cure is already in place. No one asked for a recession but the truth is that it sparked an awakening that is causing us to rethink the notion of debt-related risks. Wealth-ravaged consumers are already saving more. The government is discussing how to restructure. Just as saving was lost during the decades when we spent too much – now some spending will be lost as we reverse engines and save a little more. How can that be bad or worrisome? Wolf laments that it will cause another recession but that knee-jerk Keynesian reaction misses the boat.
How can it be wrong to point-out the true sources of our problems and directly address them? Would it really be better for policymakers to say they are going to fix the real problems sometime in the indefinite future? In the meantime instead of solutions we get speeches and weak populist-inspired temporary rebates that support and incent the very behaviors that landed us in this mess. It seems to me that the more governments credibly and quickly do something REAL about deficits and debt, the sooner people will be assured that things will get better. Those aftershocks or whack-a-moles will be minimized by market reactions that are based on credible policies that address what’s really wrong with this country. Convincing people that we are on an unwavering path to addressing our worst economic problems should send a message of optimism that can only create a climate conducive to economic growth. It might take a while, but it sure beats the hand wringing and negativism of Wolf and his fellow Keynesians.
Last line – before you call me names – please note that my optimism is based on policymakers doing the right thing… and soon. That is, my optimism is conditional. If our government and Fed continue to stall on the right policies, then I would suggest that we all move to Vietnam. It is cheaper than China and the beaches are beautiful.

Sunday, May 23, 2010

Is the sky falling?

After the operation, Mrs. Weiner was told by her doctor that the operation was a success but that the recovery period would be long and challenging. “You will be improving, but there will be set-backs. There will be times when your temperature rises, you will experience pain that comes and goes, and your strength will oscillate. There will be some days when you will have to stay in bed.” The first day back at home her temp went to 101 and she panicked. Doctor, what’s wrong? Please help me!
What are we to assume about Mrs. Weiner? Does she have a bad memory? Does she not trust her doctor? Or does she simply have little experience with this kind of recovery and isn’t so sure that 101 degree temperature is something to ignore?
This little scenario seems appropriate for our current situation with global stock markets. Didn’t we all hear that this would be a rough recovery? Didn’t we know that the road to economic health would be long and with times of regression? Was the latest batch of bad news really enough to cause such panic in global stock markets? Are things about to get much worse? I don’t think so, but there is much we need to attend to as a nation before these apparently disproportionate attacks subside.
Think about all the tidbits of news you have heard about the economy in the last few months. No, the news did not make us want to light firecrackers or pop champagne corks – but it has provided some reason for confidence. Inflation seems well under control, employment may be firming, earnings have been decent and sales have been growing. Compared to a year ago – clearly the news from Main Street has been quite cheery.
So what’s all the fuss about in the markets? Much print has been devoted to our friends in Europe. Some relevant news relates to Asia. But it is hard to believe that this could have caused such chaos in financial markets. Asia is growing so rapidly that we are worrying that they may need abrupt pullbacks in China, India and a few other places. Too much strength hardly seems a reason for the value of wealth to decline as much as it has. Mudslinging in Europe also seems unlikely to cause the financial earth to move. It really isn’t news that Germany plays to its own drummer. The script has been the same for at least 50 years. Some event calls for more control in Brussels and it takes a lot of time and sausage on the wall before the members of the EU (now 27) give up a little more of their independence.
I know I make light of the current challenges – but I find it very hard to believe that the euro or the EU is going to disappear anytime in the near future. Would Spain really have done better this year if they were not in the EU? Sure, the peseta would have depreciated -- but my guess is that it would have dropped like a rock – not something anyone in Spain would have enjoyed. They know they are much better borrowing the credibility of the union than off on their own with one more tool of macro policy! The last time I looked, countries are lining up to be part of the euro – not asking to leave it.
So what’s the rub? Why are stock markets crashing down around our ears? I think it has something to do with the fact that most of us don’t trust our economic doctors. They tell us they fixed things but all this is pretty new to most of us. If you have some financial wealth you want to protect it. When times are good you want the money generating nice big returns. But the second you think that things are going to worsen you sell and put the money in safer places. We have our collective ear to the ground for the slightest hints of a rumble of trouble.
Will this ever change? I think so, but it will take a while. First, we know this will be a long recovery. Until employment is rising in a sustained way, we are going to be skeptical about Main Street. I am optimistic that we are not so far from that point. Second, we are still watching various governments work on financial market fixes – legislation that changes the way that Washington or Paris or Brussels interacts with the world’s banks and financial institutions. We don’t want these companies to cause another financial crisis – but we also don’t want them so hamstrung that they can’t do their jobs. This regulation is slow coming. It will take some time before the public trusts that it will be done right.
Finally – while Greece and a few countries have bitten into fiscal reform – the rest of us have done very little to stave off a future attack from what are now colorfully called bond vigilantes. It is real to worry about the fiscal health of the US. Recently a couple of good economists – Alan Blinder and Martin Feldstein – independently wrote articles ( ; )suggesting that it is not too hard for Congress to show good faith with respect to fiscal problems. They argue for tax and spending changes that could be announced today but which would begin to bite in the near future. Such legislation, however, would take compromise by both political parties – something which appears impossible today. Until the fiscal imbalance is dealt with, I suspect Mrs. Weiner would be crazy not to call her doctor as frequently as her symptoms arise. She will be nervous for quite a while and so will we.

Tuesday, May 18, 2010

How low will she go? Limbo like the euro.

European officials publicly put on the brave face and exclaim that the euro is a strong currency and will stay that way. The European Central Bank (ECB) has had an exemplary record and thus, there is no reason to worry about the value of the euro, they say. Apparently a euro traded for as little as $1.23 early in the week. Once a fine Finnish lass could command as much as $1.60 with a euro – compared to that the current value represents a depreciation of almost a quarter of its value. Of course, when the euro debuted in 1999, the first monthly average was $1.16. After its opening bow, it subsequently fell in value and remained at less than par ($1.00) for a couple of years. While fluctuating, it remained above par from 2003 onward. Right now we have some forecasters saying it could go back down to $1.16 – since the opening value was thought to be close to the expected long term equilibrium.
If you are not already sleeping or emptying the trash, you might be wondering how and why a currency could fluctuate from around 85 cents to $1.60 and have a long-term economic value of about $1.16. So let’s work on that.
Economists often use a concept called purchasing power parity (PPP) to determine long term equilibrium value of an exchange rate. It focuses on fundamentals – and ignores the many things that might lead to short terms changes. Most of us, by the age of 60 know our long-term average weight. After a week on vacation, we weigh a good bit more than our average. After an extreme and often stupid diet we may look like Twiggy, but such sveltness doesn’t last. Anyway, our weights can fluctuate around an average and so can an exchange rate. This fundamental long term value is thought to be determined by the key factors that impact a country’s trade competitiveness (usually measured by prices on traded goods). Based on competitiveness of Europe versus the US and based on the past performance of the dollar versus a precursor of the euro called the ecu (this link takes you to a graph of the euro/ecu versus the dollar ) we once thought the long-term value was about $1.16.
The long term equilibrium rate is important since, like our average weight, it represents a sort of magnet that keeps pulling the exchange rate back to a specific value. It is also a clue as to whether or not the currency is under- or over-valued. I am guessing that this long-term value is no longer $1.16 and is somewhat higher. Let’s just guess that is it somewhere around $1.20.
Why did the euro get so strong in past years? Why was it recently well above $1.20? To answer these questions economists usually use a supply and demand model – supply and demand for foreign exchange. These models usually assume that changes in the short term value of an exchange rate are driven by three main factors – (1) fundamentals that drive trade, (2) government pegging, and (3) the behavior of speculators.
Any change that might have led to world consumers and investors purchasing relatively more (less) goods, services or assets in the EU (US), would increase the demand for euros and cause the value of the euro to rise. And any significant speculation that the US economy was encountering difficulties would find speculators smelling the blood – dumping dollars and causing the value of the euro to rise. It was easy to see much concern over the US economy leading up to the recession – a concern that was not as evident with respect to Europe. It was easy to see why the euro was rising before the recession began.
It is very interesting that along with this worry about the US was a belief that much of the world’s economy had decoupled itself from the US. This was a strange idea given the size of US trade but it led to an expectation and a confidence that even if the US entered a recession, it would not spread to Europe or Asia with anything like the intensity of the past. If anything what helps to explain the recent weakness of the euro it is how badly Europe fared during the global recession. Whereas the US has exhibited many signs of recovery, fewer indicators point to a strong rebound in Europe. Then when you add the Greek crisis you have even more reason to sell riskier euro-based assets in favor of US bonds.
The red herring is how the speculators behave. EU policy has been dramatic – which can be taken one of two ways – as a sure sign that doom is around the corner or that smart policymakers have adequately handled the problems. It is not hard to see a very negative tone in the press. If EU policymakers act responsibly and vigorously attack large government deficits across Europe, this will weaken Europe in the short run and have negative consequences on the euro. If EU policymakers do not act responsibly then people will lose faith in Europe and the euro will decline in value. In as much, speculators might push the euro lower and clearly many won’t be satisfied until they push the value toward parity. While Euro policymakers made a big show of defending the euro and taking on these speculators, should things get worse these policymakers could be mightily tested.
Luckily the EU is not alone. We in America can out-deficit our friends in Europe in a flash. This is a great opportunity for us to show leadership in fiscal responsibility. And it would be fun to sing IWanna Hold your Hand with the Beatles. Meanwhile Europe will have an impossible time coming to grips with almost insurmountable social and economic challenges of defining what fiscal responsibility means in a union with 27 independent states. Until that gets solved I am betting on continued euro weakness. Prague is lovely this time of year.

Thursday, May 13, 2010

What’s around the Macro-Corner?

I have some personal business this weekend and won’t be on line again until Monday. So please write your comments but note that I won’t be able to approve and publish them until I return.
There is a lot of concern about the US and global economy. Will we have a double-dip recession? When will the unemployment rate come back down to normal? These are just a couple of the macro-things on our minds. They weigh on us in a time when there seem to be no easy answers. This may not be a replay of the Great Depression, but it is definitely the worst economy that many of us have ever seen. And we are worried the future might be worse.
So “What’s around the corner?” is a very legitimate thing to be asking. We have a lot of people competing with each other to help us know what is coming around the bend. In fact, it is hard to escape all these newscasters, politicians, and various talking heads. Many of these people base their views of the future on models. Some economic forecasters use very complex and complicated models with 100s of variables and theoretical inspirations from Keynes or Friedman, or other great economists. Other forecasters focus on what they consider to be a few key trends. Others seem to speak from their guts. Still others simply want fame and/or money.
But let’s all agree with George Will who said, “The future has a way of arriving unannounced.” You don’t have to take what I am about to say as a rejection of all forecasters. I think they are very valuable. And a lot of times they get it right. But let’s be realistic. No matter how complicated or sophisticated a model might be, its forecasts are extrapolations of the past. They are extrapolations based on theories and concepts that are as thorough as we can make them but admittedly they leave out what could turn out to be critical information that makes the future different from the past. WE DON’T KNOW THE FUTURE AND NEVER WILL. THERE WILL ALWAYS BE THINGS LEFT OUT OF THESE FORECASTS. Clearly in today’s wacky environment there is much we could be overlooking.
Here are some examples that show how far off we can be in knowing about coming big changes?
o In the 1950s, despite the end of World War II and the economic stimulus it provided, we did not enter a new age of Economic Stagnation as many economists predicted. These models missed something about confidence and private spending.
o In the early 1960s models did not account for the impact that growing government deficits and monetization of those deficits might have on the future course of aggregate demand.
o In the late 1960s and early 1970s a growing expectation of future inflation and how that would impact unemployment and inflation was not well understood.
o When oil prices rose from $3 to $12 and then from $13 to $39 in the 1970s, many economists predicted that oil prices would soon spike at $100 per barrel. They didn’t. In fact they never got much above $13- $18 for a long while.
o When the Fed pushed the Fed Funds Rate to around 20% in 1980, many hoped but few people believed that this effort would be followed by a long-term period of disinflation and economic growth.
o When productivity growth was growing much faster than anyone expected at the end of the 20th century in the USA, few people knew why it was growing so fast and few predicted that strong economic growth could come without increases in inflation.
o Aside from a few people, who really saw the bursting of the bubbles in the US and Europe in 2008 and the consequences that would follow?
The point is that there are plenty of time periods when the future had a way of “arriving unannounced.” We get surprised a lot! So how do we use that knowledge now? First, let that be a form of assurance – maybe some of these logical folks who are worrying the crap out of you right now, should be given a little less credence. What are they missing? Second, things might turn out to be even worse than those people are saying – but then again, they might turn out better.
In the name of brevity, let me summarize this with the following. Whatever happens in 2010 and 2011 won’t be fully expected and probably won’t be the end of the world. “S__t happens.” We react and then we adjust. We adapt EVERY year whether they call it a recession or not. Every year people get unemployed and have a difficult time dealing with it. Every year firms go bankrupt. Every year there are people who hate their bosses and it makes them crazy and unhappy. Whether it is 10 million or 5 million people unemployed next year, we will deal with it. But the truth is that we can’t know the future so let’s not let it ruin a very nice day – today. Have a great weekend.

Saturday, May 8, 2010

Monetization for Europe – Take two aspirins and your head should clear up soon.

The front page headline of the Financial Times on Saturday May 8, 2010 is “European banks in bonds plea.” What’s the story here? Basically the commercial banks of Europe are worried that spillovers from the Greek sovereign debt crisis are going to result in much higher risk premiums and tightened credit across Europe. So instead of the banks going to the individual governments of Europe and asking them to do something about national creditworthiness, they are instead pleading to the European Central Bank to become the “lender of last resort for Europe.” Clearly, if the problem is caused by large government deficits and debt, it can only be truly solved by rebalancing these equations.
Now maybe there is some fine print somewhere that would let the ECB become the lender of last resort for Europe, but the last time I looked the ECB was an independent central bank and could not monetize debt of European countries. The ECB can conduct a looser monetary policy and it can buy more government bonds to do so – but it can do this only if inflation is not near or above 2%. With inflation in the 16 countries of the Eurozone at about 1.5% in April, this clearly gives them some wriggle room – but probably not enough to accommodate the begging bankers.
It goes without saying that there is a financial crisis in Greece that is spreading through Europe and beyond. It is true that the Fed vigorously acted as a buyer of last resort in the last years. But one wonders where this will all end. Yes, inflation is low in most countries today. Yes, there is plenty of slack on world labor and goods markets to prevent inflation from suddenly rising in the very near future. But it is also true that the most past virulent hyperinflations got started somewhere -- and mostly from central banks monetizing large government deficits. At what point do which governments begin leading the parade of fiscal responsibility? At what point do banks and private citizens begin to worry about the devastating impacts of runaway inflation associated with excessive national and world liquidity?
Let me end by cutting to the chase. The deficits, debts, and ensuing financial problems we are experiencing today are the result of governments who fail to pass the fiduciary test. They have been warned for years and in some cases for decades about getting their fiscal houses in order. Well – the day of reckoning has finally arrived and few are talking seriously about real fiscal solutions. Mostly we get smoke and mirrors. Instead we put pressure on central banks to bail us out. But the truth is that there is no end to these problems without fiscal solutions. Monetary remedies will do no more than a couple of aspirins when it comes to solving the drunk’s problem.

Friday, May 7, 2010

Mixing can lead to headaches. How much did employment increase in April?

My father always drank Vodka on the rocks. He warned me that mixing liquor with anything except ice cubes would produce undesirable results the following day. While I mostly drink bourbon or sour mash, I generally follow his advice. And as a good son, I try to follow it regularly.

I wish the press had learned from my Dad. On Friday the US employment data for April was announced with most headlines noting that payrolls rose by 290,000 while the unemployment rate rose from 9.7% to 9.9%. This seeming incongruity was swept away with a passing reference to growth in the labor force. None of this is incorrect but unless you are a macro-nerd and go to the appropriate place -- -- you could be seriously misinformed.

You will not learn from most of the headlines that employment actually increased by 550,000 persons in April. The issue and confusion – did employment rise by 290,000 or 550,000 – seems worth discussing further. One television commentator was trying to calculate how long it would take the unemployment rate to reach an acceptable (lower) number if job growth continued by 290,000 per month. Of course, she was using the wrong number – it would take about half as long as she calculated if employment continues to rise at 550,000 per month…

So what is all the fuss here? The source of the problem is that the Bureau of Labor Statistics of the US Department of Labor publishes two surveys each month – the Current Population Survey (which tells us employment and unemployment numbers) and the Current Employment Survey (which tells us the number of jobs created). Or more briefly, these are called the Household Survey and the Payroll Survey.

The Payroll Survey is a measure of jobs but not employment. The monthly sample covers 390,000 nonfarm establishments – government and private. These nonfarm establishments tell the government the number of jobs on their payrolls. If a person works for two firms – one full-time and one part-time – they would be counted twice. Anyone self-employed or working for a company categorized as agriculture, would not be counted in the Payroll Survey.

The household survey involves about 60,000 households. They are asked about the labor force status of each household member. The survey classifies each person in the household in one of three ways – (1) in the labor force with at least one job (employed), (2) in the labor force and looking for a job (unemployed), or not in the labor force (16 years old or older and not looking for a job). If you want to know exactly how they categorize people through the survey, go to

The household survey counts you as employed or not – so it underestimates the number of jobs. It also includes self employed persons, people who work in agriculture , and unpaid members of a family business. Because it is a sample and prone to errors, the BLS explains that it takes a change of at least 436,000 to be statistically significant. So the 550,000 has meaning for April.

The April Household Survey estimated that the labor force increased by 805,000. That means that 805,000 people wanted a job and 550,000 of those people found them. It also means we added 255,000 (=805,000-550,000) to the pool of unemployed. Thus the April unemployment rate (all people unemployed of 15.2 million divided by all people in the labor force, 154.7 million) rose to 9.9%. But surely the good news is that 550,000 persons found work and there were 255,000 encouraged enough by current conditions to move from not looking for work to looking. Compare that to most of 2009 when the civilian labor force was declining.

Wednesday, May 5, 2010

Greece, Grease, and Wazzup wit U-Rup?

There is a lot of macro going on right now but much of it is being pushed below the surface by car bombs, Ahmadinejad’s nomination for the Nobel Peace Prize (just kidding), Steve Hogan’s win in the Bloomington primary, and Greece. So I thought it might be a nice time to take a step back and talk about Greece and Europe. Most of us Americans know that Grease was a cool musical with John Travolta and Olivia Newton-John. We also know cool stuff like who sang Under the Board Walk, who won the Kentucky Derby, why the Dodgers left Brooklyn, and how many Mannings play quarterback in the NFL. We Americans know a lot of cool stuff.

When I was growing up in Miami, Europe was a continent and a place that had a lot of World Wars. I heard it had a lot of cathedrals but none of that was ever much of a draw for me until my dear friend and mentor Chuck Bonser invited me to join him on a program in Europe. I think I went three times – two weeks each time – and I heard lectures by Europeans about Europe in places like Paris, Brussels, and Berlin. What a lucky duck! I am not an expert on Europe but I do know enough to try to add a little perspective to what is going on there and why it is such a big mess.

What we call the European Union or EU started shortly after World War II mostly because Germany and France decided that if they created more economic trade (iron and steel) between their two countries they might not want to kill each other so often. Before you know it they added Belgium, the Netherlands and Luxembourg and created a union of five countries. I suspect these three additions had less to do with coal and steel and more to do with really good beer. Anyway, I digress. From there we see an expansion from five countries to 27 and some 450 million people. Sixteen of those countries decided to drop their own currencies and adopted the euro when the Maastricht Treaty was signed. Since 1999 we began thinking of the euro as Europe’s currency despite the fact that many European countries are not part of the Euro-Zone and still have their own currency (E.g. Britain).

Enough history. Now some facts and wild guesses. First, despite the EU and the Euro-Zone, the countries of Europe are NOT like states in the US. They remain independent countries ruled by their own governments. They have made scores of agreements with each other that help facilitate European-wide trade and monetary union. These agreements bring wealth and prosperity to the people of the EU. They have great value and will not be reneged easily.

Second, it somehow APPEARS to some of us that there is more union than there really is. For example, the EU has government institutions that sound a lot like a federal government. There is an Economic Commission and an Economic Parliament. There is also a recent agreement that looks a lot like a Constitution. There is a new EU President and someone who acts a lot like a Secretary of State. Sounds like a country to me.

Third, appearances can be misleading. For example and relevant to 2010 and Greece (but not to Grease or the Drifters) is that while those in the Euro-Zone agreed to give up their currencies and let the European Central Bank determine their joint monetary policies – they did not give up their FISCAL POLICIES – that determine government spending and taxation. All 16 Euro-Zone countries have their own government spending and tax policies. For the sake of the monetary union they did agree to some constraints – to keep their fiscal deficits at no more than 3% of GDP and national debt at no more than 60% of GDP.

So when Greece (and Spain, Portugal, Ireland, and others) were found to be exceeding these fiscal limits, the rules required that these countries grapple alone with their fiscal problems, subject to fines if they habitually exceed the fiscal limits. Despite all the agreements within the EU and the Euro-Zone, there is no agreement that provides a European solution for countries that have debt problems. Germany’s original response was something like – let them charge higher taxes on gyros. Good German citizens are not going to bail out Greeks who spend so much time at the beach. Strange thing happened then – their shared currency, the euro, started to depreciate as if all those 16 countries were scofflaws.

Accordingly, the Germans and the French and the rest of the countries felt compelled to act. Only problem is that there is no legal EU means to do so. So now they are being more flexible and more innovative. Only trouble is that they are not yet being very convincing despite the fact that the IMF jumped in with their considerably deep pockets. It took a while to come up with a solution for Greece and now the world is wondering just how bad things are in the rest of the countries. Until more of this is digested and understood, the euro is bound to be under some pressure. The members of the EU are under a lot of pressure to restructure their rules. Until they do, the world’s financial markets are watching. This is BIG STUFF since the very act of restructuring means another round of compromise—individual countries giving up sovereignty.

Okay – so now I feel better. I feel good enough in fact to find a nice Belgian Wit in my fridge. If only I could find some Dutch pommes frits. Yummy. I hope you all had a nice May Day. Today is Cinco de Mayo which in Spanish means a big headache on May 6th.