Tuesday, December 30, 2014

Is There Ever Enough Regulation?

In the Wall Street Journal last week (12/24/14, Page A15, Good Medicine for Bad Bankers) Alan Blinder laid out his plans for more government regulation of banks. While seeking more regulation is not unexpected coming from a liberal like Blinder, it is the increased intrusion and non-stop zeal that is so frightening. 

Most conservatives understand that companies and their employees can be dishonest and will break legal and ethical standards. Conservatives understand that free markets don't solve all our problems. While most of us could debate until the cows come in just how much regulation and government spending is warranted or beneficial -- most of us would settle on something well north of zero. We get it Mr. Blinder. 

But at what point is enough enough? At what point do we ease into the Nanny State? Let's get back to banking. DF goes a long way to regulate banks. Some of us think it goes too far in some ways but we understand that banking is complicated these days and it doesn't hurt for government to put some curbs or brakes on riskier banking activities. After all, if government is going to subsidize or insure some bank deposits backed up by our tax money, then it makes sense that society should have some say so about banks. DF has a lot of say so. DF went through Congress and was signed by the president. There are also international accords that regulate bank risk exposure. 

Some might think that enforcing criminal statutes and DF would be enough -- at least for a while. But not so for Blinder. He wants to muck things up even more. His article quotes a Fed Official William Dudley as saying that there are just too many bad bankers these days. They do some really awful things apparently and are not being harassed enough by people in government who apparently never do anything wrong and are much better at banking than are the bankers. So what does Blinder recommend.

First, he wants whistle blowers to be encouraged and treated more kindly by their companies. Perhaps they should post photos of the "whistle blower of the month" on the company's Facebook Page. Then we can count all the Likes they receive. The ones with the most Likes get free tickets to an IU football game. Second he wants to regulate the pay of bankers so that they focus less on the short-run. 

Everyone loves to get paid for today's work when hell freezes over. Right?  Third, anyone caught doing something wrong would be not only convicted but would be barred from banking for life. I wonder how the unions would go for that one? Fourth, each bank would have a point total score -- sort of like airline frequent flyers points. These totals would accrue each time a bank was caught doing a no-no and would somehow be published so that all of us dummies would know exactly which banks were repeat offenders. Maybe a weekly tweet of bad bank scores would get the word out. Finally, when a bank was fined or otherwise punished -- it would not be enough to whip the CEO in public. Instead the government would require everyone in the offending part of the bank to be spanked in the town center by the principal. 

So Mr. Blinder. ARE YOU KIDDING? Why not do these same things to Pharmaceutical companies? How about all those companies who advertise great deals buying gold today? Then there are those wonderful firms who heavily advertise reverse-mortgages? Why stop there? I am sure there are evil and mean-spirited owners, managers, and employees in EVERY INDUSTRY who stay up all night conjuring up ways to deceive the public. 

This is nuts for a couple of reasons. First, we spent a lot of time and energy passing legislation over the last 50 years -- are you kidding about these suggestions? Did you copy this crap from one of your student's freshman exams? Second, are you sure you want our government to have regulators who tell business people how to run their companies? Do you want them to institutionalize whistle-blowers? Do you want to regulate pay? Do you  want to have government employees infringing on the rights of union employees to keep their jobs? Do you really want a government that often has strong ideological goals deciding which companies are the bad guys? 

Some of you are saying cool. You love the idea of government controlling these bad actors. To you I say -- just wait until the government thinks your company is one of the bad guys. Or maybe just take a peak at Cuba or China and see what it's like when liberals get their wish. 

Tuesday, December 23, 2014

Christmas 2014

My good friend Ron, a reader of this blog suggested that publishing on December 23rd might be a little ballsy. After all, you important folks have a lot to do to get ready for Christmas and archery practice. So I decided to follow his advice and post something whimsical, though highly meaningful.And by that I mean I am posting my 2014 Christmas list. For those of you who do not celebrate Christmas you may substitute another word for Christmas or for list or for any other word above if you want. This is a free country you know.

In reading this list you will notice that I did not include JD. I figured that would be sort of err redundant. There are only 18 items because I am not greedy and I forgot the other ones.
  1. Cuban Cigar
  2. Free popcorn and flack jacket with ticket to  “The Interview”
  3. Elizabeth Warren Jockstrap
  4. A one-pee night
  5. One channel that has news
  6. Fed Impatient about Interest Rate above Zero
  7. Honest politician
  8. Mung Bean Bindaettoek at Gwangjang Market
  9. Putin and Bieber in the rear view mirror
  10. Sing one song live with the Temptations or Four Tops or Justin Bieber
  11. Ribeye Steak as big as my head
  12. Cash
  13. A liberal/progressive who will write a guest blog for me
  14. Another grandson
  15. Wearable Camera for the Back Door
  16. Paul Krugman's speaking fee
  17. An Uber gift certificate
  18. Another daughter named Ashley
I hope you have a great Christmas and a very Happy New Year. 

Tuesday, December 16, 2014

Guest Blogger Harvey H. Homitz on Global Climate Change

From the desk of:  Harvey H. Homitz 
p.o. box 436 Sanibel, FL. 33957

to: Justin Gillis 
C/o. The Editor,
      New York Times, New York, NY.

Re : By Degrees.  
        New York Times, Science section, Tuesday Nov. 11th. 2014

Dear Mr. Gillis,

Congratulations! You are indeed the lead trumpeter for the NYT Green Warming Marching Band if you dig my tune.!  Nothing wrong with blowing a good trumpet,  even if it is for the NYT,  but be careful!  Remember when Joshua blew his at Jericho....the walls came tumbling down.   
We don't want that happening in New York! Right?

Let's not mince words!, for a while now  I've been following  your 'BY DEGREES' piece on Global Warming, or what they now call Climate Change.  That terminological reconfiguration was a smart move, nothing wrong with that!  Better be safe than sorry I always say, especially for you journalists when you get into the prognostication business.  

So! We've got the outcome thing covered but all this headlong charge into Wind and Solar has been bothering me for a while  and I'm relieved that finally you got it ..  Justin Time eh!  
Oops ! I forgot; Justin Gillis.

Well done! You hit the Danes on the Jutland with that one!    What are those 5.6 million Danes going to do when the wind stops blowing and the Norwegians won't give back the electricity  they owe from pumping up their hydro electric dams when there was too much wind? And Danish wind to boot.  More to the point what are they going to do when 45 million Brits., who shut down their Nukes and dirty old coal plants, are begging for a few tera-watts  to save them from freezing in the dark? Eh?

Well I don't mind sharing this one with you; the Brits will do OK without Danish Wind. They've got Lord Browne Fracker!  You know,  the chap who changed British Petroleum to Beyond Petroleum,  jumped out of the closet, quit BP and started fracking all over North England.  

Now you seem to be a bright sort of fellow, very literate if not so numerate.  After all, apart from a few recent exceptions, there's  not many Dodos on the NYT payroll, so you may have guessed by now that I am packed in the sardine section of an Airbus, at Mach .75 , 35k ft. and reading your piece in the Times.  Incidentally, when you say "BY DEGREES" are we talking about Fahrenheit, Uncalibrated, Celsius or Kelvin? Perhaps you should put that little circle with F, U, C or K after 'degrees' so that any real scientists reading it would know what the f*** you're on about.

Now Articles like yours  tend to make one think.   So it occurred to me as I sipped an inferior wine while nibbling fruits and nuts, (appropriately  since I was departing California which is well endowed with both), how lucky I was to be propelled by kerosene and not Danish wind.  Further, with the aid of a slide-rule, (which need not be switched off in flight),  I calculated that it would require 70,000 horses or 350,000 galley slaves at max exertion, to get this Airbus off the ground. Suddenly the sardine section seemed less crowded!

Well, not to worry, you're on the right track now, and being an expert in these matters myself, I don't mind helping you avoid the obvious pitfalls while sweeping on with the grand fallacy.

As luck would have it I'm available.  Let me know when we can start.

Yours from the Last Bastion of Independent and Unfunded Natural Scientists,

Harvey H. Homitz

Purveyor of Sensible Science to Innumerate Literati.

Tuesday, December 9, 2014

Low Oil Prices? I don't think so.

Oil prices are low. Groovy! Hold on they tell me. Low oil prices are bad. What? Tell my new gas guzzling Santa Fe that lower gas prices are bad. Tell my wallet. What is going on here? We cried and moaned every time we went to the gas station for years and now that gas prices have dropped a few cents, we are supposed to see a crisis in the making? This is economics gone wild

Where to start? Basic economics. Suppose people want fewer Thingies. This leads to a lower price for Thingies. Firms supply fewer Thingies to the market. That sounds pretty intuitive. People want less so firms supply less. It happens all the time. So when global demand for oil started to fall and this caused the price of oil to decrease, it makes sense that oil firms produce less. What is the problem? The problem is that some folks are worried that the price will fall so far and get so low that most firms would lose money selling oil and the supply would dry up.

Now you see the rub. But come on guys – what are we assuming here about oil firms? Basically the worry warts are saying that firms are passive entities who bark at the ring of a bell.

First, is it not possible that oil firms could work harder at cutting costs to remain competitive at lower prices?

Second, is it not possible that firms could innovate or find better ways to make money with oil? Notice that when prices are high and rising there is very little incentive for oil firms to cut costs and innovate. But when they are falling, the stakes are much higher and there is plenty of incentive for protecting profits.

Third, is it not possible that firms who got rich when oil prices were super high might have invested or saved some of that money for a rainy day?

Finally, is it possible that oil prices are not yet really so low that we have to worry?

It is this last question that I want to address here. Are oil prices really so low? So I found some data on crude oil prices. You can get data back through 1776. Ha ha. No you can’t. But you can get them back to before I was born! I found monthly data on crude prices and I mostly wanted to focus on when they got interesting – after the early 1970s.

Before 1973 crude went for about $3 a barrel.

After two oil crises we found oil near $40 by 1980. You have to admit that is quite an increase. My allowance didn’t go up nearly that much.

At that time a strange bunch of fellows who were part of a group called the Club of Rome predicted that oil prices would soon reach $100 per barrel. Unfortunately their timing was quite wrong as oil prices fell below $40 very soon and basically fluctuated for the next 24 years! Yes, it took until 2004 before oil prices reached the magic $40. $100 per barrel sounded pretty stupid.

One reason for telling the above story is that we have mental giants who like to extrapolate the latest changes into the forever future. What goes up must go up! That same logic prevails with some people today. Oil prices went down so they must keep going down. Maybe they would go to -$100 if only prices could be negative.
The Club of Rome must have started singing JD drinking songs because they finally got their wish in 2008 when oil prices climbed to about $133 per barrel. I wish all of my forecasts would turn out correctly 38 years later!

Okay, Larry get to the point. As I am typing a barrel of crude oil costs about $66. Is that a low price we should worry about? Well, it is low compared to the $133 of 2008. But then it is quite high compared to the $39 per barrel of February of 2009. Are you getting seasick yet? Yes, oil prices oscillate like crazy. But even more telling is the fact that $66 per barrel is HIGHER than virtually every month since 1946 except for a little burst in 2006 and another one from about 2010 to sometime in 2014. 

If oil companies could make money on oil during all those months when it was priced at $66 or less, then I am guessing they will be okay now and they will continue producing oil. While $40 dollars a barrel might be a little tougher on them, I am guessing they could survive prices less than $66.

Some of you sharp cookies might worry that I haven’t accounted for the general level of prices. After all, $66 dollars today buys a lot less than it would have bought some years ago. So I deflated the CPI energy Index with the CPI. Guess what? Even if you account for general inflation, energy prices today are higher – not lower – higher than in most months since the 1970s. That is, a dollar earned from energy buys more than it did in the past. For example, in 2002 a dollar of energy could buy only about 60 cents of consumer goods and services. In September of 2014 a dollar of energy could buy a whole dollars-worth of consumer goods and services.

So whether you deflate or not, oil prices are not low at $66 per barrel. If anything they are high. I am not about to begin weeping JD tears for these energy companies. Most of them will do fine, especially the ones that aggressively invest, manage costs, and innovate.   While supply of oil might decline because of good economic reasons, it is hard to imagine a future energy crunch like we had in the 1970s. In the meantime, enjoy pulling up to the pump and paying  $2.something for a gallon of gas. 

Tuesday, December 2, 2014


Ferguson has no significant macroeconomic impact. But no self-respecting blogger can ignore all the words and scenes associated with that town near St. Louis, Missouri. One could not get through Thanksgiving or Black Friday without constant reminders and it threatens to keep going for some time.

My take is broader and more personal than the police case. I have heard and read so much about Ferguson coming from so many different viewpoints that it does none of us any good for me to regurgitate or pile on.

Ferguson makes me think of what happens in every family. Ashley screams – Jason hit me. Jason explains that Ashley kept bugging him. Ashley retorts that she bugged him because he took her soccer ball. Jason explains that all was great before Ashley was born. It is pretty obvious that no amount of accusation is going to solve anything. 

Timeout for both of them is a temporary but an effective way to restore peace and quiet. Jason and Ashley are now grown and are great friends. How did we get from there to here?

I don’t mean to make light of racial issues in the US. But it does seem to me that if we get beyond the actual legal case in question, we quickly realize that much of the intensity of the aftermath involve whites and blacks talking or shouting over each other’s head. From my vantage point nothing very constructive is happening. It is like Jason and Ashley when they were kids. A timeout is called for.

Another parental approach for rival siblings is to follow timeout with a second stage. Okay – the two of you will go into one room with a locked door and you may not come out to play or eat or send texts or do anything until you explain how you are going to get along better in the future.

That’s what I would love to see. Let’s face it. Blacks can charge that some whites are racist and they place numerous roadblocks to prevent Black success. Whites can point to persistent social problems among black communities that contribute to Black problems. Inasmuch we shouldn’t for a moment – whether we are Black or White – praise the progress that has been made in race relations. The elephant in the shop is a shameful lack of racial progress.

That’s where this gets personal. I remember growing up in Miami – I was born there and then left to go to Atlanta to college. Racial segregation was the ruling culture in Miami. As a barely middle income kid, my neighborhood was on the border of the black section of Coconut Grove. I saw lots of black people. But I never went to school with one in segregated public schools. As you may know, blacks were required to sit in the back sections of buses. I never had a black friend until a summer job when I was 18 years old.

I could go on but you get the picture. The point of the picture is that my parents taught me that segregation is immoral. They believed there was no excuse for the way Black people were discriminated against and they firmly believed that in my lifetime things would change for the better. I never challenged that. It was hard to believe – especially after the Civil Rights movement, that segregation and discrimination would be measurable 50 years later.

My parents were both right and wrong. While Black ghettos remain, many escaped segregation and many have done well despite being minority citizens in a majority White country. While the advancements are real and recognizable they remain insufficient. That’s the elephant in the room. Damn it, it is deplorable that so much inequality and discrimination still exists.

And of course, depending on your race or your ideology you are now ready to fight. And you might want to start with me! Whites point their fingers at Blacks and vice versa. But in my humble opinion, neither side is willing to admit that both are responsible for the lack of progress. But they are. Both Blacks and Whites contribute to segregation and inequality. Both blacks and whites hold on to extreme ideologies and historical mistrusts and hatreds. Both blacks and whites hold on to stories that “prove” they are right.

Well, they can hold onto all that destructive crap all they want. Maybe it serves the wealth and power of some. Maybe it is easier to stay segregated? All I know is that we can and should do better. Segregation and racial hatred are immoral and wasteful. What I know is that it will take REAL leaders on both sides who really care about human beings. It will take sitting together in a room for as long as it takes to begin a sincere dialogue about mutual errors and potential successes.

I spent time this Thanksgiving holiday with some of my grandchildren. Maybe you did too. What are we supposed to tell them about the next 50 years? That’s what Ferguson means to me. 

Some may call me simplistic to believe that leaders could sit down and make progress on something that has festered for more than half a century. And maybe it won't happen. But let's face it, doing nothing or relying on violence is just going to make things worse. I'd rather harp on the real but unpopular than to continue the disastrous status quo of finger pointing. Now where is that JD? 

Tuesday, November 25, 2014

Slow and Unbalanced Growth in the United States

Like a pig in mud, I love to root around in the data. A macro guy loves it when the BEA releases another quarter’s worth of GDP.  Like a goat on top of a waste dump, you just never know what you will find. So you just dig in.

And I did just that. The data for the third quarter of 2014 was recently released and now that the smoke has cleared, I thought I might spend a perfectly fine afternoon seeing what I could see. And the results are pretty interesting. Have you heard the term “unbalanced growth”? The US economy looks today like a teenager with a pea-size head and arms that drag on the ground. We can only hope that things equalize in the future!

I use the Q3 results to do some comparison analysis. I could wait a few months to do this exercise but I could also wait to bite into that super-hot slice of pizza too. So we could get a collective burnt roof of our mouth here by focusing on the third quarter. But what I do here is as kosher as a Wolfies hot corned beef sandwich on rye. So not to worry.

The first thing I noticed is that the annualized value of real GDP reached $16.2 trillion in 2014 Q3. Now that is a pile of stuff. Back in 1999 Q3 Real GDP was $12.1 trillion. So in those 15 years we increased national output by about a third. Even if we compare today’s output to 2007 Q3 right before the recession started, we are enjoying 7% more than 7 years ago.

7% more in seven years is nothing to write home about but it does establish that even after a major recession and an ensuing slow growth period, we are producing a large amount of output today – considerably more than the outputs of the past.  Again – I am not making a case that things are wonderful in Macroland. But the most recent data establishes the fact that we are producing more than ever.

That fact might not be surprising but it gets a lot more fun when you bring out the Hookah. Err I mean the rest of the data. As you probably know, real GDP has several major components – based on the buyer – households, firms, governments, and the foreign sector.

So let’s see how these sectors contributed to the larger amount of production in the USA. That is, who is responsible for buying about a third more when we compare 2014 to 1999? I summarize with the table below.

The table has component shares of Real GDP. If the share of a category was 10% in 1999 and then 10% again in 2014 – that means that that buying by that group kept up with GDP. The share did not change in those 15 years because it kept up. So in the final column in the table – a POSITIVE SIGN means that category was growing FASTER than Real GDP in those 15 years. A NEGATIVE SIGN means it grew SLOWER than Real GDP. 

What do we see from the table? First, we definitely have unbalanced growth. Second, while consumer good spending was a leading sector, the growth was coming mainly out of durable consumer goods like autos. Spending on nondurable goods like food and clothing did not keep up with RGDP as its share of spending fell. Third, while the federal government purchased a larger share of the nation’s output, state and local governments’ share fell by 2.7%. Finally and perhaps most importantly, gross private domestic investment’s share fell from 18.5% to 16.8% of GDP. Yes spending increased, but it grew considerably slower than real GDP for the last 15 years. As you know this category is the key to future innovation and productivity. While there was a marginal increase in the share of business purchases of equipment, it was the structures part of investment that lagged. Similarly on the retail side, residential housing’s share fell by 2.2% of Real GDP. Finally while exports' share rose by 3.5%, imports share rose by 2.7% and therefore net exports increased by only 0.7%.

Keep in mind that Real GDP increased by about 33% in 15 years. But that amounted to an average of less than 2% per year. All those categories in the table with a MINUS sign, therefore, grew more slowly than 2% per year. The slow growth economy of the last 15 years essentially was propelled by the Federal government (shares of defense and non-defense increased by similar percentages ) and household spending on durable goods and was held back by State and Local Government spending and the construction of business and residential buildings.

One could conclude the slow economic growth was caused by a highly unbalanced growth and recovery. One could also conclude that whatever policies offered to promote recovery have not worked. The Keynesian spending multiplier is premised on the idea that while stimulus might be aimed at a single sector, the results would spread across the economy. Such has not happened and it might help if policymakers try to understand why.

Table. Share of Real GDP in Q3 in 1999 and 2014 and Change
from Q3 1999 to Q3 2014
                                               1999  2014  CHG
Exports                                      9.7   13.1     3.5
PCE                                         64.6   67.9     3.3
Durable Goods                          5.9     8.8     2.9
Imports                                    12.9   15.8     2.7
Investment in Equipment          5.6     6.3     0.7
Federal Government                  6.8     7.1     0.3

State and Local Gov.               13.6   11.0   -2.6
Residential Investment              5.3     3.1   -2.2
Investment in Structures           4.1      2.8   -1.7
Gross Private Investment        18.5   16.8   -1.7

Non-Durable Goods                14.9   14.6   -0.3

Tuesday, November 18, 2014

Guest Blogger Chuck Trzcinka The Psychology of the Minimum Wage

Chuck Trzcinka is Professor of Finance and James and Virginia Cozad Faculty Fellow of the IU Kelley School of Business.

The political support for raising the minimum wage stems from psychology not economics. The economics is abundantly clear-the minimum wage cuts jobs. The higher the minimum the more the harm. The Congressional Budget Office released a survey of economic studies last year and concluded that raising the minimum wage to $10.10 will reduce employment by between 500,000 to 1,000,000 jobs. When you increase the cost of something, business will find ways to reduce its contribution. For example, McDonalds has added 7,000 touch-screen kiosks in its European stores. Furthermore, the survey showed that over 70% of those receiving the minimum wage are not from poor families. The CBO argued that a better way to help is to raise the “earned income tax credit” would have little effect on jobs.

So raising the minimum wage, even having a minimum wage in the first place, makes no economic sense, but it is unquestionably politically popular. Voters soundly rejected Democrats in Tuesday's election but embraced a visible plank in the party's platform by backing minimum wage hikes in four Republican-leaning states and two cities. By January, more than half the states will have higher wage floors than the federal government. Voters in Alaska, Arkansas, Nevada and South Dakota passed ballot initiatives raising the minimum wage to $9.75 an hour even as they swept Republican Senate and gubernatorial candidates into office. All told, the initiatives will raise minimum hourly earnings for 609,000 low-wage workers, according to the National Employment Law Project.

            Why is it so popular if it doesn’t help the poor? The reason is that it makes us feel better. Psychologists use a concept called “cognitive dissonance” to describe a situation where facts confront our most basic views. For example, young people are reluctant to save for retirement because this means accepting that they will grow old. Similarly, when we interact with low wage workers it makes most of us uncomfortable. They only have skills that command a wage below what we think is below a “living wage”. It is certainly below our living wage. The low wage confronts our belief that we are living in a “fair” economy.  Our response is psychologically to reduce the source of dissonance. If we raise the minimum wage we will either eliminate the job or have a higher wage worker. We will not ever meet a low wage worker and we will believe that the economy is more fair and just. The minimum wage is really about making those who are wealthier feel better.

The problem of course is the economics. The poor would be far better off if the minimum wage was lowered or eliminated and we expanded the earned income tax credit. But then our idea of “fairness” would be challenged by low wage workers. We would never think to ask any of these people why they were willing to work for a low wage since this conversation is uncomfortable. It’s better to get government to impose a wage floor and never meet them. 

Tuesday, November 11, 2014

Guest Blogger Buck Klemkosky: The QE Punch Bowl Has Been Taken Away. Is the Party Over?

William McChesney Martin, former chair of the Federal Reserve Board, famously stated that “the job of the Fed is to take away the punch bowl when the party is still going.” A quote from the 1960s, but very relevant today as the Fed voted in October to end the third quantitative easing (QE3) program.

At the end of six years of QE programs, the Fed had purchased $3.9 trillion of mortgage-backed securities and Treasury bonds, increasing its balance sheet from $800 billion to $4.7 trillion. This represents 26 percent of U.S. Gross Domestic Product (GDP), a historically high amount, relative and absolutely. But the Fed is not alone. The Bank of Japan just announced its QE program will be expanded and its balance sheet is already 57 percent of Japan’s GDP. The European Central Bank has just started a QE program and its balance sheet, at 21 percent of Euro GDP, will certainly get larger.

What did the Fed do before QE? For 95 years of its 101-year existence, the Fed exerted monetary control through short-term interest rates, supplying credit to the banking system to lower rates or withholding credit to increase rates via open market operations. The Fed also has the right to change reserve requirements for the banking system, the amount of cash and other liquid assets banks need as a percent of deposits, and the discount rate, the amount the banks pay to borrow reserves from the Fed. The Fed also has used selective credit controls and moral suasion. The short-term interest rate targeted by the Fed is called the “Fed funds” rate which is based on interest rates for overnight loans between U.S. banks. This rate was fairly easy to manipulate when there were $30 billion-$40 billion of excess reserves in the banking system. At present the Fed is targeting a range of 0 to .25 annual rate for the Fed funds rate.

What are the implications of Fed monetary policy since the new unconventional tool of quantitative easing has been initiated? The big question now is whether the Fed will be able to raise the Fed funds rate in the future. As the Fed went through the three QE programs, it purchased bonds from banks and others and paid for them by crediting bank reserve accounts at the Fed. To the banks these reserve balances were as good as cash that could be lent out or invested. Because of the slow-growth economy, low loan demand, Dodd-Frank and other issues, the banks left much of the reserves at the Fed recreating $2.7 trillion of excess reserves, those not needed to support deposits. With that magnitude of excess funds in the system, the Fed will find it challenging to raise interest rates via traditional methods. There is no longer a viable Fed funds market. Plus the Fed has already announced that it will maintain its $4.5 billion balance sheet so selling a lot of bonds to drain liquidity from the system is not an option. What to do? The Fed could raise the interest rate on bank reserves. However, this may not be politically feasible because it would be boosting bank profits, including those of foreign banks with U.S. deposits, with no risk on the part of the banks. Another alternative would be to target other short-term bank borrowing markets such as the Eurodollar, Libor, commercial paper and repo markets. 

It is difficult to assess the effectiveness and impact of the QE programs as we never know what would have happened if there had been no QE programs. It is also difficult to differentiate between the impact of the QE programs and the zero interest rate policy the Fed has maintained since late 2008. But certainly the QE programs have reinforced expectations that short-term interest rates would not be raised as they have not been to date. The S&P 500 closed at an all-time high in November, the U.S. Treasury 30-year rate and mortgage rates were below 4 percent, the yield on the 10-year Treasury was below 2.5 percent, unemployment was 5.9 percent and the Shiller Case housing index has rebounded 25 percent since the lows of 2011. So it has been successful by some measures. But, the economy has grown only by 2.2 percent annually since the recession ended in June 2009, way below past economic recoveries. Inflation has also remained subdued, averaging 1.4 percent annually since the recession ended. The Fed has a 2 percent inflation target and inflation has been below the target for 29 straight months. The Fed remains concerned about the economy and the deflation that Europe and Japan have already experienced.

Some think that QE is a dangerous monetary tool because of unpredictable side effects. One would include igniting inflation and inflationary expectations beyond the Fed’s 2 percent target if banks stimulate the economy with their $2.7 trillion of excess reserves. A second would be financial instability as investors take on more risk reaching for yield and creating asset bubbles. A third is that the huge Fed balance sheet may interfere with conventional monetary policy and tools in the future. Only time will tell whether the side effects and effectiveness of the QE programs are understated or overstated. The debate may go on for years.

Whenever the Fed choses to do so, the task of raising interest rates has gotten more difficult and risky. When will that happen? The consensus seems to be mid-2015 at the earliest and perhaps not until 2016. When it happens, let’s just hope that the QE punch bowl doesn’t leave the economy and investors with a hangover. Or the punch bowl may need to be refilled (QE4) to keep the party going.

Wednesday, November 5, 2014

Trick or Treat -- The Fed's Balance Sheet

Like many of you I have been reading all the articles written about the US Fed ending its quantitative easing program. There is enough stuff there to choke Mr. Ed the talking horse. As I was reading it occurred to me that I am a total monetary geek. I was still wearing parachute pants when I took my first course in money and banking. Since then I have become a Fed Watcher and can’t wait until the minutes of the last meeting of the open market committee.

So let me say that I was mystified that little of what was written in the last week focused on one critical aspect of the Fed’s balance sheet. And there was a lot written. Much was a postmortem on quantitative easing. Did it work or not? And while looking at the past is always valued, we should spend equal time thinking about how the end of quantitative easing will affect the future.

The frustrating thing is that what was written about the future uses too many code words. I don’t know how many times I have read that quantitative easing has increased the size of the Fed’s balance sheet. How many of you know the definition of a balance sheet? How many of you took Professor Gamonida’s accounting class at Georgia Tech and learned about balance sheets? Aha – not many of you. How many of you have ever learned a thimble full of information about the Fed’s balance sheet? Aha!

So in the name of global harmony and to the tune of the Georgia Tech Fight Song, I will quickly and easily introduce you to the arcane basics of Federal Reserve Accounting – and more importantly explain why a key issue is being ignored.

The first thing to note about balance sheets is that they are not found on your mattress under the quilt. A balance sheet brings together much of your financial stuff. On one side its lists the value of all the good stuff like your cool Converse Chuck Taylors, what’s left in your bank account after your spouse went for her weekly facial, saving your saving account balance, your house, your car, cash stuffed in your pillow, and your Uncle Charles. Just kidding, your Uncle Charles in not an asset. All the other good items you own are called assets.

Your balance sheet also has another column that lists all your ouch stuff. Mostly that’s what you owe. So if you owe $46,000 on your Yugo, then the $46,000 loan is called a liability. You have liabilities or debts under such categories as credit card debt, car loans, mortgages, college loans, and so on. The money you owe to Pete your gambling friend is often not included in public balance sheets.  If your assets do not equal your liabilities there is always a balancing item that makes your assets equal your liabilities plus balancing item. But we don’t need that fact to go forward.

Are we going forward? Are you awake?

The Fed has a balance sheet. It is very cool. The main asset the Fed holds is bonds. The Fed at last count has close to $4.5 trillion of bonds. Wow.  $4.5 trillion could buy a lot of chicken wings at Buffa Louie’s. Most of these are government bonds with short-term maturities. But since quantitative easing started, more and more of these bonds are longer-term government bonds and housing market derivatives.

What you read about over and over is that the Fed’s balance sheet rose from just under $900 billion to about $4.5 trillion. Fed assets exploded because of QE. And like your waistline after a six month luxury cruise, the amount is still with us. In the name of colossal calamity, the Fed bought an extra $3 trillion or so of bonds and still holds them. As of last week they are no longer buying more bonds. But the stockpile remains.

Much of what you read focuses on this stockpile. Will the Fed let it slowly mature and just burn the cash when they receive interest and principle? Or will the Fed quickly get rid of all those bonds? Clearly if they did the latter it could be disruptive to credit markets. So the Fed is in a bond pickle and that’s what everyone seems to be talking about.

But that leaves out one spectacular element. Why did the Fed buy all those bonds in the first place? Is the Fed a bondoholic? Aha! They bought all those bonds because that is how they flood the economy with money. Between say 2009 and today, the Fed added about $3 trillion of money to the economy. The hope was that all that extra money would lead to bank loans, spending, and economic growth. But what happened was that after averaging almost zero in 2007 and 2008, bank excess reserves rose to about $2.8 trillion today. That is, banks did not loan out much of that money. They asked the Fed to hold onto it for them. Perhaps holding it for a better day when people really want to borrow money. Meanwhile the Fed is sitting on money that the economic system has shown it doesn't want.

All this information about money and bank reserves is what is found in that second column of the Fed’s balance sheet and is called liabilities of the Fed. And that is what is not being talked about much in the papers. Your kids came home from trick or treating with a mountain of candy. What are you going to do with all that stuff? Your kids do not need all that candy and Fed and the banking system do not need all those excess reserves. 

The Fed could quickly get rid of those reserves but they worry it will disrupt markets. The way to reduce the excess reserves is for the Fed to sell their assets. All that selling could be disruptive to bond markets sending bond prices down and rates up. Yellen and her gang do not want to be held responsible for driving up rates. So what is there to worry about? The Fed is holding a bunch of money for banks who don’t want to use it. No big deal. Right? Wrong. As the economy recovers, borrowers will return to banks. And banks will have an almost limitless fund to make those loans. It is like all that Halloween candy. You can hide it from the kids for a while, but sooner or later they will find it and you will soon have a problem on your hands. Better to trash the candy on November 1.

QE was a travesty because we all knew this would happen. The Fed has put itself in a no win situation. It made a big announcement last week to stop doing stupid things. But now it is stuck with a mountain of stupid things. I guess we never learn.

Tuesday, October 28, 2014

Taming the Deflation Dragon

The Deflation Dragon is roaring and Keynesians are licking their chops. Like those who promote fad diets and weight loss pills, Keynesians are appealing to your inner anxiety and love of easy solutions rather than telling you the truth about what ails the world economy. A typical article on this topic is one that appeared at Bloomberg.com last week --  http://www.bloomberg.com/news/2014-10-22/currency-wars-evolve-with-goal-of-avoiding-deflation.html

This Bloomberg article does a few things. First it does a nice job of reporting deflation changes in various spots around the world. There is plenty of it. I have no argument there. Second, it connects exchange rate depreciation wars with these deflation occurrences. Finally the article concludes that if exchange rate depreciations will not successfully end deadly deflations, then we should deal with it with “whatever means is necessary.”

Clearly more people are coming to the conclusion that widespread deflation needs to be reckoned with and that typical Keynesian approaches that boost aggregate demand must be administered. These approaches include depreciating your exchange rate, goosing money and credit, and having larger government deficits and debt.

The intuition is simple but deceptive. Draw a supply and demand curve diagram. Shift the demand curve downward. Notice the resulting lower equilibrium price. Now shift the demand curve rightward. Viola – the equilibrium price rises back to normal. Furthermore, equilibrium output (and presumably employment) increases. QED. Demand is the problem. The problem is evidenced by deflation or falling prices. The problem is rectified by increasing demand. Don’t you just love economics! Now I can drink my JD and spend the rest of the day watching leaves fall.

I agree with the whole Supply and Demand story but disagree with how the world can best push that lagging Demand Curve back to a better position.  Conventional Keynesian wisdom reflexively wants the government to manage the Demand Curve through exchange rate, monetary, and fiscal policies. But in 2015 world economic problems require a very different potion. Even the master of all this theory – J.M. Keynes, if alive today would have looked at today’s situation and balked at the traditional Keynesian remedies.

Why would Keynes balk with Keynesianisms? Because Keynes lucidly and powerfully expressed the idea that confidence and fear were important motivators. When writing about the Great Depression it was Keynes who explained that monetary policy would be like “pushing on a string.” This meant you could push money into the system but because of lacking confidence, banks or firms or households would simply hold onto the money. They would save or hoard it. They would not spend it. He called that “the liquidity trap.”

So Keynes established why fear made monetary policy ineffective. Living today and seeing how governments have backed themselves into huge debt corners, he might also conclude that fiscal policy won't work in an environment where governments were defaulting on debt. I am not sure what Keynes would say today about exchange rate policy but such policy is not one that every country can employ. This is a zero-sum game. If one country depreciates its currency to stimulate demand for its products, then another country has to endure an appreciation and a reduction in demand for its goods and services. Already the US is getting unhappy with Japan and other countries that are making gains at US expense.

Larry you are so depressing! I am not. I am fun! There is a solution to deflation but it involves not calling the 800 number for another fast acting pill. Think about what most countries have been through in the last years. Think about the real credit and financial problems faced by household, firms, and governments. It might sound humane and nice to tell US families that they can now borrow 97% of the price of a new house with less stringent income requirements. But surely all those stories about under-water mortgages are still fresh enough to make potential home buyers know that this is not an attractive option.  Basically it is snake oil.

The solution is the same one the doctor gives to the patient undergoing rehab. Keep at it. Keep doing those exercises and someday you will regain better use of that limb. There is no easy way. There is no pill or diet. Just keep sweating and grunting and pushing to get stronger.

Today the sweating and grunting has a lot to do with reducing previous levels of debt among households, firms and governments. Either under- or over-regulation of what the IMF calls legacy problems are also part of the problem of uncertainty and insufficient demand. Under-regulation means that governments should do more to clear up financial, housing, and other problems. Over-regulation means they have done too much and have handicapped the very patients doing the rehab. Do those exercises with a 100 pound sack of potatoes on your back!

Nutshell. Deflation does exist and is a challenge. Aggregate demand is deficient in many places and needs to be prodded upward. Aggregate demand will only be worsened by policies that do not address fundamental problems. Most Keynesian remedies fall into that category. Policies that are tough but will make us stronger are what we need. We need to cleanup debt. We need to give workers and companies stronger incentives and remove impediments to work, innovate, and produce. The IMF pays lip service to such “restructuring” policies but alas in the real world the snake oil salesman seems to have more influence. 

Tuesday, October 21, 2014

The Fed, the IMF, and Stock Market Gyrations

The Fed spoke last week and the markets looked like a food-o-holics meeting at a Hardees Restaurant. I am not exactly sure what that means but I am trying to paint a picture of chaos. Got it?

What is a little different this time is that we are getting a refresher lesson in international macro. The bad news is that international forces could weaken the US economy. While we are used to news about how events in Syria and Iraq threaten us, the latest salvo has to do with exchange rates and softness in the world economy. We point our fingers at various allies when it comes to them lagging at supplying ground troops in Syria and Iraq – and now we point our fingers at China, Germany,  the EU, and various other places for not doing enough to buy our US exports. Those places are blamed for not stimulating spending enough and have let their currencies depreciate too much against the dollar.

Since the US government is incapable of managing the US economy the Fed is left as the last bastion of help to defend Main and Wall Streets. And the markets loved the idea that the Fed is truly “left” or liberal enough to think that keeping interest rates near zero for a while longer will make all the difference in the world.  It is strange that zero interest rates have been unable to spur the economy sufficiently when foreign countries were stronger – and now that our neighbors are weaker we cheer the same policies. Wow – please give me more of that allergy medicine now that I am really sick. It didn’t work for mild symptoms so maybe now it will have me dancing the jig since I am really sick. Huh?

What is interesting about all the light and fury last week is that there wasn’t any real news about the global economy. It is no secret that the dollar has been appreciating and no secret that much of Europe and Asia were struggling with growth. But aha – a report was published last week that underscored what we already knew. Somehow that underscoring of the old information was the news. Joe is 5’2” and cannot play for the Indiana Pacers. His girlfriend tells Joe that he probably won’t get a contract from the Pacers. Joe immediately becomes despondent and orders a case of JD.

The report that was published last week is the semi-annually published IMF World Economic Outlook. The October 2014 report is now widely available. Some of you believe all sorts of horrible things about the International Monetary Fund and have already changed the channel. But these reports from the IMF are well regarded and many economists and analysts come close to spiritual rebirth each time a new report is published. So let’s take a little walk down IMF Outlook lane and (  http://www.imf.org/external/pubs/ft/survey/so/2014/NEW100714A.htm ) and see what these folks told us that made us so crazy last week.

Let’s start with report’s Table 1 which lists annual growth rates for real GDP for various geographies. The last column of the table tells by how much the IMF revised its 2015 forecasts since July. Thus, the only real news is in that last column. Below I duplicate some of their findings for next year:

·        World economic growth revised down from 4.0% to 3.8%. Note 3.8% in 2015 is faster growth than in 2012, 2013, and 2014. Notice also that 3.8% is almost exactly equal to the average world growth of 3.9% per year from 1996 to 2005.
·        USA no revision – remained at 3.1% for 2015.
·        Euro Area revised down by -.02 to 1.3%. That 1.3% in 2015 compares to negative growth in 2012 and 2013 and 0.8% in 2014.
·        Japan revised down by -.2 to 0.8%. This is the slowest growth rate in the last three years.
·        Canada revised up 0.1 to 2.4%, highest in three years
·        Mexico revised up .1% to 3.5% faster than the last two years but down from 2012.
·        China no revision at 7.1% but lower than the average of about 7.6% over the last three years.

So this is what we are all getting blathered about? These are the revisions that contributed to a huge stock sell-off last week? Basically the US forecast was unchanged while NAFTA as a whole improved. Improved! The US and its closest trading partners had better forecasts for 2015 than from last July. Europe’s growth was knocked down a bit from July but growth is expected to improve in 2015 – Europe will have stronger growth than experienced in the last three years! Japan and China will have off years but notice that the world economy is predicted to grow faster than it has for three years.

There are some who say that the tone and words used in the IMF Report were more startling than the numbers I described above. So let’s see what the IMF said in its Forward – the part most people read.

It is easy to summarize. The IMF believes there are two problems facing the world right now. One is continuing to deal with the legacies of the past financial crisis. That means dealing with government debt and high unemployment. The second problem is that potential GDP is slowing.  Because of these two factors, confidence is declining.

The overall message says nothing about new shocks that might have caused them to revise downward their forecasts for 2015. Why have financial legacies and potential growth deteriorated since July? The truth is that the IMF simply saw some bad months in some bad places and decided to jump on the bandwagon of negativity. If growth is getting worse in Japan or the EU or Brazil – then surely they will continue to get even worse. Or will they?

Which brings us to the IMF’s policy remedies. First, despite noting government debt risks and pointing out that current Keynesian policies have not succeeded, the IMF wants countries to use even more Keynesian aggregate demand expansion to stimulate economic growth. Spend on infrastructure and if that isn’t enough then spend on “whatever”. Second, they recommend to most countries to use structural fiscal policies that improve the workings of labor markets, commodity markets, financial markets, government over-regulation and so on.

What I recommend is that the IMF not publish global forecasts until they actually have something to say. The above stuff is nonsense if not drivel. They want more Keynesian stimulus when it hasn’t worked and when it will explode national debt problems. They want to solve long-term issues with monetary policy that keeps interest rates low. They have been advising countries to restructure and free up their economic systems for decades with little result. Is Putin’s Russia really going to embrace more capitalism now that the IMF has asked them to do it for the hundredth time?

Despite all the geopolitical and other risks, the world economy is growing at an improving rate. Not all countries are sharing in that growth but that is usually the case. The last thing we need is for the IMF or anyone else screaming that the sky is falling. 

Tuesday, October 14, 2014

Guest Blog by Buck Klemkosky*: As the World Turns

Intro by Larry Davidson

I was in the process of writing something about recent global events when Buck beat me to it. I still have plans to write about the recent IMF World Economic Outlook report that was released last week. But in the meantime Buck brings up two very recent and potentially threatening global trends. The first one finds that the value of the dollar is rising lately and is creating new challenges for a still fragile US economy. Buck explains why dollar value changes are not that simple, however. The other interesting issue concerns global commodity prices. Most of us worry when prices of energy, steel, copper, aluminum, and various other commodities rise too much. But what happens when international prices of these items begin to decline?  I hope you enjoy Buck's take on these things.

The Dollar is Back

In the last year, the U.S. dollar has appreciated (strengthened) 10 percent against the euro and 15 percent against the Japanese yen. Most of the decline in the euro has been in the last six months, while the yen has fallen almost 40 percent in the last two years. It is not just the euro or yen either. The U.S. Dollar Index, which measures the value of the dollar again a basket of currencies, has climbed to its highest level in more than four years. Even the venerable Swiss franc has fallen 9 percent against the dollar since June, as well as emerging market currencies. About the only currency that hasn’t changed is the Chinese yuan, which is controlled by the government and unofficially pegged to the U.S. dollar.

Why do we care about the value of the dollar relative to other currencies? A strong dollar makes foreign goods cheaper and thus helps control inflation. However, a strong dollar also makes exports more costly and thus less competitive, resulting in slower economic growth. It has been estimated that a strengthening of the dollar by 10 percent reduces economic growth by 1 percent. It always pays to invest in a country with a strong currency, so a strong dollar had made U.S. financial assets more attractive to foreign investors; it has helped lower bond yields and other interest rates and supported stock prices.

Why is the dollar so strong? The U.S. has experienced better economic growth than either Europe or Japan. Both are on the verge of recession and have lower inflation or deflation and lower interest rates. The European Central Bank has initiated a bond purchase program, and Japan has an ongoing one just as the U.S. Fed will stop its program this month. Plus the Fed has already given guidance that U.S. interest rates will be increased in the future, while Europe and Japan have given no such guidance. In a broader context, the dollar remains the world’s primary reserve currency and a safe harbor in terms of crisis and geopolitical risks. The dollar will continue to anchor the world’s financial system in the foreseeable future. In the shorter term, one will not notice the effects of a stronger dollar unless traveling abroad; things will be cheaper.

Commodity Prices Tank

The closely watched Bloomberg Commodity Index, which tracks 20 commodity prices, has fallen in recent weeks to a four-year low. And the fall has been broad-based, including agricultural, energy and metal prices. How things have changed; between 2000 and 2011 commodity prices tripled, referred to as the commodity super-cycle, and there was talk of eventual shortages of almost all commodities. Since then commodity prices have fallen by about 25 percent, and 11 percent since June alone. The only commodities not to experience price declines have been cocoa, coffee, cattle and hogs.

Commodity prices are a function of supply and demand and both have had an impact this year. On the demand side, annual global economic growth has slowed from 5 percent to 3 percent this year. Global growth may not improve much in the short term as the Eurozone, Japan and other emerging countries are teetering on the brink of recession. China, the largest user of most commodities in recent year, is struggling to achieve annual growth of 7 percent. Christine Lagarde, head of the International Monetary Fund, recently declared that the global economic recovery was “brittle, uneven and beset by risks” and slow global growth may be the norm for a long time.

The supply side may be summarized by two words: “supply glut.” Agricultural commodities have benefited from good growing weather, record acreage planted and high yields, resulting in bumper crops and the lowest prices in seven years. The oversupply of most metals can be blamed on the huge investments made at peak prices to satisfy China’s appetite for raw materials and recovering global economic growth. Oil prices have fallen 16 percent since June and are at the lowest level since 2012. Much of this decline can be attributed to the shale boom in the U.S. as it replaces Saudi Arabia as the largest oil producer in the world. The U.S. imports less oil today – 3 million barrels daily – then it did two years ago. Oil prices would be lower if countries such as Libya, Iraq, Iran and Venezuela could produce at full capacity.

What are the positive and negatives of falling commodity prices? It depends on whether a country is a net importer of commodities or a net exporter. Producing countries that export suffer when prices drop and could be a drag on global economic growth. For the net importing countries, falling commodity prices are like a tax cut, leaving households with more disposable income. Since many commodities, such as oil, are priced in dollars, the stronger dollar helps the U.S. but hurts other countries where currencies have weakened again the dollar. In general, falling commodity prices are probably signaling slower global economic growth.

*Buck is Market Strategist at Wallington Asset Management.

Tuesday, October 7, 2014

Is the Stock Market Over-Valued?

The stock market swooned last week and has been bouncing around ever since. “Surely the market is over-valued” is a comment that you hear frequently.  Agreement with such a statement means that many people will be very worried because it implies that stocks have peaked and will stop rising.  Retirees never like to hear that since their future incomes are tied to future growth in stock values. But all of us are concerned – no one wants to see wealth disappear. Simply – whether you are young and beginning to save or old enough to be on a regular diet of prunes – it hurts when stock prices stop rising. It hurts even more when they fall.

So what is the truth here? Are stocks going to stop rising? Fall? Or is all of this nonsense and stocks will continue rising?

Below you will see why I am not pessimistic about stocks. But let’s begin at the beginning. What does it mean when people say stocks are over-valued? If your boss tells you that you are over-valued, you know it isn’t a compliment and it probably means no wage increase is imminent. The word “value” is a common one that most of us understand. All things have value. Even my old pair of jeans has value to someone. 

Value, however, can be a tricky thing. How about those old jeans? Some of my well-dressed friends would toss a pair of old jeans as soon as the fading begins. In contrast, my hippie friends won’t even wear a new pair of jeans until they have washed them enough times that they are not only faded but have holes in the knees. Point – the same product might have very different values to different people.

Economists recognize this dilemma but point out that markets are places where values are assigned through prices. If a house sells for 1 million dollars, that’s the value of the house. The seller may be unhappy with that price and the buyer ecstatic – but the economist records $1 million. That’s the price at which both parties agreed to the transaction.  So – implicit values can be almost anything but market price is an objective criterion widely accepted as value. If we want to know if stocks are over-valued then we use stock prices. 

What does it mean for stock prices to be under-valued? There is no single meaning. The popular way is to use something called a price/earnings ratio. P/E has two parts – a stock price and an earning figure. Think of a single firm. Suppose its stock price closed at $100.  When you buy that stock for $100 you are hoping it will be a good investment. For the moment forget the capital gain you might receive by buying low today and selling high in the future. What’s left is a dividend you might receive from that share. Let’s suppose the earnings of the company are only $1. In that case, since dividends reflect earnings, the most you would expect to receive for your $100 investment is $1. That’s a 1% return. Ugh.  That stock is over-valued at $100. If you had paid $20 for the stock, then your return would have been a much better 5%.

Some of you are waving your hands! Larry – when you pay $100 for a stock you have it for more than one year. So what matters is not just one year of dividends or earnings – but what happens to earnings over the future. And for that question/comment you get a gold star. But that’s what gets us into trouble with this price/earnings approach. The current price and earnings data are known but are not perfect. But to use future earnings brings in unknowns and expectations and lots of different opinions. Ron might think a stock is vastly under-priced because he sees large increases in future earnings. James is more pessimistic about earnings and thinks today’s stock is highly over-priced.

So while the price/earnings approach is one that is widely used – it isn’t perfect for determining when and if the stock market will fall or rise in the future. It is a valuable approach but it leaves room for other ways to think about stock prices. Since I am about as boring as a rock in a stream, I like intuitive simple approaches. Consider some facts about the market. Here I am using the S&P500 price index. I downloaded data for the time period from 1950 to September 2014 from a website (https://finance.yahoo.com/q/hp?s=%5EGSPC+Historical+Prices ).  I then graphed the data. I converted all this daily data to annual averages. My limited abilities mean I couldn’t get the graph on this page. But you can find a graph at the link above.

·        Similar to my waist size – the S&P500 has had up and down cycles many times but it has trended upward.
·        The value of the S&P index in 1950 was about 17 and now hovers at about 2000. You math jocks can figure out the rate of return of $100 invested in 1950.  It is a pretty big number. If you gave that money to Uncle Charlie (or Uncle Sam) in that year, your return might not have been so good.
·        During those years there were many times when the market surged ahead only to return to more sober (lower) values. Many analysts point out a period from the early 1970s to the early 1980s when the market was essentially flat. But that is about the only time since 1950 when the market did not pop back in a more reasonable period of time.
·        Looking at the graph from 1995 to 2000 and then from 2003 to 2007 the increases where spectacular. Both peaks were followed by declines that lasted 2-3 years. The declines were followed by more increases.
·        There were also interesting time periods when stock prices rose precipitously but did not fall for extended time periods. If you start in about 1975 the market rises through the early 2000s with several major spurts followed by shorter setbacks.

The above points are pretty well known but they do underscore one fact – market gains always have setbacks but those time periods vary greatly in their intensity from a couple of months to several years. Gains do not necessarily imply a seriously stagnant market price.

Now one more point. If you put money into the S&P500 in 1995 or 1996 and held it until it reached 2000 last month – your annualized continuously compounded yield would have been around 7%. That annual appreciation is very much in line with stock returns over a much longer period. An average market, therefore, is expected to give you about 7% per year. Now consider the recent time periods of so-called explosive growth. If you invested money in the year (first column below) and sold when the market hit 2000 recently*, your investment would have earned the average compounded rate (column 2) over those number of years (column 3):

1997      4.5%   17
1998      4.3%   16
1999      3.0%   15
2000      2.4%   14
2001      5.2%   13
2002      7.8%   12
2003      6.5%   11
2004      6.0%   10
2005      5.6%    9
2006      5.2%    8
2007      3.9%    7
2008      9.4%    6
2009    13.6%    5
2010    15.1%    4
2011    20.9%    3
2012    17.8%    2
2013    18.9%    1

*Rates of return in the table are calculated from September of each year given through September of 2014.

From the above table you can see dramatic growth of the last five years. Those are indeed spectacular returns. But if your eyes move up the table you see that even with these fantastic stock increases, the annual average returns from money invested anytime between 1997 and 2007 yielded below historical averages. Thus even with spectacular growth of the last few years – the longer term returns in the market are well below average.

What do you make of this? The answer is that there is no way to know the future. Price/earnings ratios are interesting but don’t tell the whole story. Returns of the last five years are indeed spectacular. But even with stock price increases in those five years, money that got invested 7 to 17 years ago are not impressive. Stocks could rise several more years before that money earned the average annual return.

Will the market peak soon and swoon? Will it remain at present levels for 10 years? I don’t know. But the answer is clearly not a slam dunk.