Tuesday, August 26, 2014

Unemployment Whack-A-Mole: Fed Futility?

What goes down must come up?

Let's suppose your friend told you about a great new diet that promised to get your weight back down to normal. Cool, eh. Now let's suppose you talked to a bunch of people who all told you the same thing -- after losing a lot of weight  on this diet they would always regain it again -- and often would end up weighing more than when they began. I would stay away from that diet. The story for the unemployment rate is not too different from this diet. The chart below helps you see the similarity.

The Fed has a dual mandate. In addition to controlling inflation it is also supposed bring about full employment. Since we don't know how to measure full employment this at least means the Fed is trying to reduce the unemployment rate. As long as UN is higher than some pre-ordained amount or so long as labor market conditions do not signal imminent inflation, the Fed stays with its mission to reduce UN.

Listening to the FED one  might think that the goal of low unemployment is something you can shoot for and then attain. Once attained all that work should pay off for a while. While  it is true that reductions can last for a while, what is also true is that once you drive the UN rate too low -- it spits back at you. Just look at the graph below. Notice the sudden upward spikes that quickly undo almost all the good that came before.

  • In 1953 UN almost doubled in one year from 2.9% to 5.6%
  • In 1958 it jumped from 4.3% to 6.8%
  • Between 1969 and 1971 it jumped from 3.5% to 6%
  • Between 1979 and 1981 it increased from 5.9% to 7.6%
  • Between 1950 and today there were at least nine periods in which the unemployment gradually fell from a high level only to bounce back to an equally  high level. 
  • If you draw a trend line through the whole chart it suggests that whatever process was making UN go up and down over time was raising the average unemployment rate in the long-run
  • Drawing a trend line after 1980 you get a downward slope or a flat slope. But the minimum unemployment rates are still much higher than in the pre-1970s. 

 Notice that most of the Fed discussions these days revolve around whether or not rising inflation is imminent. So long as inflation is not ever present, the Fed seems confident that its focus on unemployment is without risk. But today's story and chart has said nothing about inflation. Today we are discussing UN and UN. The relevant question is when does Ms. Yellen stop pushing UN down? This chart says it isn't clear exactly when to stop. Before the 1970s if the Fed stopped pushning at 4% or 5% UN, they might have averted a resumption of high UN. But notice how all that changed in the 1970s. In that decade pushing UN below 6% was dangerous. 

With UN at about 6% today, Ms Yellen suggests that we look at other labor indicators as she continues with her hand on the throttle. Sixty years of UN suggests she refocus policy before we find ourselves with another horrible spike in UN -- one that will leave us with few policy tools left to employ. 

The problem we see playing out over and over is not hard to understand. Which is better when cutting down a large dead tree: a chain saw or a hundred unemployed workers with nail files? While the latter seems inefficient but human -- it is not. Unemployed workers want real solutions not temporary band-aids. The labor market can be temporarily satisfied by bursts of money but the real fixes to sustained increases in unemployment have to follow from the real causes of the unemployment problem. What is causing UN to fall so slowly in the USA? Why are people dropping out of the labor force? Why are wages so slow to increase? I doubt any of this has to do with too little money in the economy. Focus on those things and maybe we won't have to suffer another terrible UN spike in 2015. 

Tuesday, August 19, 2014

Income Inequality and Economic Growth

Dad, can I have some money? Why do you need it honey? Because my friend got hurt and it makes me sad and if I bought a chocolate bar I might feel better. In that case, honey, here’s a five dollar bill. I hope you feel better soon. Come on. That is the dumbest reason ever given for wanting money from Dad and no kid would ever try it. But alas, Alan Blinder is up to his old tricks again and his article amounts to asking for that chocolate bar, “The Supply-Side Case for Government Redistribution,”” Wall Street Journal, August 15, 2014, page A13.

On July 1 I wrote a post Blindly Following Alan Blinder Over a Poverty Cliff. In that case I reviewed Blinder’s desires to expand most social programs aimed at low income persons.  Blinder never bothers with evaluating these programs and just cavalierly advocates expansion. If one billion wasn’t enough then we should try 2 billion.  In this August article Blinder gets more brazen when he concludes that long-run economic growth can and should be expanded if we spend more money on social programs.

Those of you who are not familiar with economic literature or colonoscopies should know that there is nothing written much-less proved or demonstrated about poverty programs causing economic growth. There are reams of articles written about the reverse – the impact of economic growth on poverty – but alas as Alan Blinder was hitting his deadline for the WSJ, he came up with a new and earth-shattering economic truth. If you want to increase economic growth then you should spend more money on programs for the poor.

Many of you will say that it sounds intuitive that helping the poor will create more economic growth. Widely shared economic growth models explain changes in long-term economic growth with several key indicators – labor, capital, and productivity. If turning a poor under-educated and unskilled person into a new and productive worker in the labor force can be accomplished, then the growth model shows how and why poverty programs might lead to stronger economic growth. And the reverse would be true too – rising poverty leading to fewer good workers in the work force would be bad for a country’s economic growth.

But just like needing chocolate to make you happy because your friend fell off her bicycle makes sense at some level, poverty programs simply are not an explanation for economic growth. The proof is in the pudding. Blinder made this whole thing up last week. Please someone show me in a journal or a book or a classroom or on a bathroom wall at an Irish Pub in Itaewon where economists have some sort of evidence to support the relevance of this idea.

There are several ironies here beyond lack of scientific rigor and evidence. First, Blinder says he wants to talk about the Supply-side as a means to promote stronger economic growth. Please pass me more JD. Isn't he among a group of liberal economists who routinely decry and label supply-side policy in the most horrible terms like trickle-down, Trojan Horse, and more? Second, Blinder says in the article about the ethical issue of poor people, “Either side can talk until it’s blue in the face without convincing the other.” Blinder apparently believes that ethics is not going to solve the poverty problem. 

Third, Blinder then goes on to minimize the case for improving national spending.  He argues that most people spend the same. Thus if you take $100 away from a person making $200,000 per year and give it to someone with $20,000 income per year – it would have no net effect on national spending. Thus poverty and income redistribution programs get no support from Blinder for ethics and spending.

And so we are left, according to Blinder, with economic growth. Help the poor more and the economy will grow stronger and faster.  And we better do it fast because we are becoming more unequal all the time. An afterthought of his article is that this inequality is exploding in both economic and political terms. That means we are all going to suffer because this will hurt economic growth even more. This is nonsense. I personally feel better about helping the poor because it is the right thing to do. And as I said in the last post, we do that best by first evaluating the programs we already have. We have 50 years of experience with such programs. An honest evaluation would find strengths and weaknesses. Why can’t we do such an evaluation before adding more fuel to the fire? 

Tuesday, August 12, 2014

Trade with Africa – More Trade or Foreign Aid?

Last week the President not only met as planned with 50 or more leaders from Africa but he followed it up with a major budget proposal and a press conference. Despite wanting to watch my favorite shows on Fox Business News and the Bourbon Channel, I got the pleasure of our President announcing some new and important initiatives. If you read this blog with one or more eyes open, you know that I love trade. And I even stuck up for the US EX-IM bank because it facilitates more US exports. I love to hear plans to increase US trade – exports, imports, capital and more. So I had to listen to the President.

Meanwhile Russians were putting more troops in position to fight in Ukraine, Christians were being murdered in Iraq, Israelis were fighting in Gaza, and Republicans were doing all sorts of evil in America. So given all the items on the President’s agenda, you have to admit that Africa must be very important to the US for the President to pour out another half-million words on TV.

I decided that I haven’t bored you readers with data in a while and I was curious how the President was going to do really great things empowering Africans to help themselves and to buy a bunch more of our exported goods. To preface this data mining experiment let’s start with a few points. First, we are engaged and have long been engaged with giving foreign aid in Africa and many countries. But this speech and the $33 billion the President wants to send to Africa is not being marketed as more foreign aid. This is all about creating more business for American companies and workers. According to his speech, this is all about trade – not aid. 

Second, if it is about trade, then there ought to be some bang for the buck. A policy to increase US exports (or imports or capital) ought to have some impact. Third, it not only has to have some impact but it also ought to have the best impact. Okay so a policy might increase country A’s purchases of US goods by 49%. But if that 49% increase amounts to a tiny amount of dollar orders for Kentucky bourbon compared to a similar policy in country B, then you might prefer to direct the order to country B since that will generate more US sales, employment and profits. 

What I illustrate below is that President Obama’s new plan for Africa is mostly about more foreign aid. Africa is not a good place to increase US trade. If it is about trade – we would be better off spending that $33 billion elsewhere.

Let’s start with goods and services exports. The US wants Africa to buy more US stuff. In the first six months of 2014, the US exported $804 billion goods and services to the world. Africa bought $19 billion. The whole continent of Africa bought 2.3% of US exports. In contrast this is what other regions bought (in billions):
            World                                 $804
   North America                      273
   Europe                                 170
            Pacific Rim                           119
            South/Central America            91
            OPEC                                    39
            Africa                                     19

Egypt and South Africa were the two largest African buyers of US goods and services, buying $3.6 and $3.1 billion respectively. If we doubled exports to those countries it wouldn’t amount to a hill of beans to US workers operating in a $15 trillion dollar economy producing a couple trillion dollars in exports each year. 

The US Bureau of Economic Analysis (BEA.gov) also publishes direct investment data by country destination. Direct investment (plant, equipment, etc)  by US companies in the world in 2013 amounted to $4.7 trillion. That’s how much “capital” our companies owned abroad. That ownership increased by about 25% between 2010 and 2013. Below are comparison figures that put US business investment in Africa in a global perspective. First is the amount for 2013 in trillions of dollars and in parentheses is the percent change between 2010 and 2013:

            Europe                     $2.607   (28%)
            Asia Pacific                 .695  (22%)
            Islands  W. Hemis        .601   (16%)
            Canada                        .358   (25%)
            S. America                  .169   (23%)
            C. America                  .113   (15%)
            Africa                          .060   (  9%)
            Middle East                 .045   (32%)
When it comes to US business investments across the globe, Africa has not been a major destination. It stands out on this table for two reasons – the small amount and the very low growth rate of 9% in three years. One has to ask a question when seeing this – why haven’t companies been more interested in Africa and what is it about the President’s new program that will change those reasons substantially?

 The answer is pretty simple. By and large, African countries are dictatorships that score high in corruption and low on income. Not all African countries are the same. But spend an hour Googling lists of countries by corruption, or income per capita, or percent of people below the poverty line – and African countries are always well represented. A richer country like Egypt can be used as an example. According to the World Bank, Egypt’s income per capita is about $11,000 (South Africa was listed at about $13,000). Cubans make $19,000 and Puerto Ricans earn $35,000. Germans collect about $43,000 per year. With respect to people living in poverty, Nigeria had about 55% of the population labelled as poor. Egypt and S. Africa were more like 23-25%.  Naturally the same countries scored high on indexes of corruption.

Tourists love the diversity of colors and cultures in Africa. But such diversity is not great for US companies who want to penetrate new markets. In Africa there are 54 countries. It is believed that Nigeria alone has more than 500 languages/dialects. Our President says he wants to create more trade across the continent. But diversity in South America should be a caution to what can be expected in Africa. While South American companies have become more global in recent years they have not done it by trading with each other. Often they are more trade-loyal to their colonial pasts than to their regional presents.

The President cited many statistics that show that some Africa countries are growing and could become better trade partners. But let’s be honest – growing from a low base is one thing. Large enough to matter is another. Either call that $33 billion foreign aid and try to give it in ways that will reward and promote less corruption and more democracy and enterprise – or call it trade promotion and give it somewhere that is more apt to bring a strong return in US trade and employment. The last I checked we still have a huge national debt, a slowly growing economy,  and little room to employ precious national  resources inefficiently. 

Tuesday, August 5, 2014

Monetary Fables and Sand Traps

It is said so many times now it is almost a mantra – Then Fed engineered a recovery for Wall Street, leaving Main Street and most of us to suffer or at least languish. The intuition is easy. Think of Ms. Yellen in a helicopter spewing hundred dollar bills over banks that collect them in giant bins and then hide them in big vaults away from public view. What money does leak out of the banks goes to purchase bonds and stocks and sustains a financial bubble or at least a rally. Fed behavior also keeps interest rates limbo low and cause reallocations of portfolios away from money and into more risky bonds and stocks with higher promised returns. Firms are not allowed to borrow and expand and therefore employment does not increase and both consumer and business spending remain in the doldrums.

I would be surprised if this story has not already made its way into Dr. Seuss or other children’s books.   It has appealing though contradictory themes. The big bad Fed is a lackey of the right wing helping to keep the upper 1% as rich as possible while regular folks suffer. Alternatively the Fed is a willing compatriot of the liberal left, but alas needs to do even more to complete the task. The Fed pumps money into the economy willy nilly praying each evening to Paul Krugman that money will work wonders for Main Street. Surely if the Fed continues on this course and pumps in ENOUGH money, the economy will be saved. Imagine Paul Krugman in tights with a large S on his chest.
Neither of these stories is correct. 

Let’s take the first one. The first one is based on the idea that when the Fed injects money into the system it somehow prefers the filthy lucre to end up in risky financial markets instead of supporting loans that expand the economy.  This one is pretty silly. I don’t know of one money and banking book that suggests any reasons why the Fed would want the rich to get richer at the expense of the rest of us. Historically it is hard to find times when the intention of a loose monetary policy was to avoid real loans and pump up stock markets.

As for the second story, it is true that there is a lot of hope and faith when it comes to money’s magical impacts on employment and output. But this current episode goes beyond hope and even Paul Krugman seems to have lost his tights. Historical amounts of money have been pumped into the US economy and rates have been kept at zero levels for a long time. Yet, the economy stalls. John M Keynes, the great one, recognized the limits of money when he cleverly invented the so-called liquidity trap. Modern Keynesians agreed a long time ago that once a country enters the trap it is like a monetary Bermuda Triangle in which everything gets sucked onto a giant hole never to be seen again. Money can approach savior status but not when expectations are tender. It makes no sense to keep pouring money into this economy and it makes no sense for money to pull us out of slow growth. This is what Keynes and his band of merry Keynesians said to Maid Marian and Friar Tuck.

Most textbooks and Fed statements suggest some very clear avenues about money. The money mechanism is simple but it is full of traps. Here is the usual story.

·        The Fed sends a check to a bondholder in exchange for his bond. Bond interest rates fall.
·        The check is deposited in his bank.
·        Banks have more money and do not need to borrow to raise funds and the Federal Funds Rate (FFR) falls.
·        Since the FFR is a cost of funds, this causes other interest rates to fall.  
·        Households and firms hop on the first bus to their banks to borrow money.
·        With these low-priced loans consumers buy durable goods and firms buy capital goods.
·        All this spending causes firms to hire more workers and expand output.
·        Christmas comes early.

If the above sounds like a fairy tale to you it is because you have learned about the traps – all the things that could go wrong so that none of the above actually happens on your planet. So here is a brief list of these traps:

·        Liquidity Trap: Bondholders are more than happy to sell their bonds to the Fed so bond returns do not fall much.
·        Deposit Trap: Worried about banks, investors do not deposit checks in the banks. Money might leak out directly to shadow banks or financial investments.
·        Loan Trap: either banks do not trust borrowers or borrowers are too indebted to even ask, so loans do not increase.
·        Spending Trap: No loans, no spending.
·        Employment Trap: even if households and firms do begin to want more goods and services, firms may be pessimistic about the future and not want to make permanent increases in employment or output.
·        Uncertainty Trap: so long as policymakers keep trying to make things better – and they don’t get better – firms and households become even more uncertain and conservative in their decisions.
·        Left tackle Trap: when the left tackle feigns a missed block and the defender comes rushing in for glory and finds that the left guard is there to smash him to the ground.

My first point is that the Fed need not be a lackey of the left or the right if it somehow misread a golf course full of traps. Why do so many golfers end up in sand traps? Because they know they need to take risks to come from behind. They need a low score and at the moment they are way behind the leaders. With unemployment at 10% and a mandate to reduce it, the Fed chose a risky path that ended up with us in a lot of traps. Because the recession was not your run-of-the-mill downturn, the Fed did not anticipate a lot of the traps. Once in the traps we lose. You would think that recognition of such mistakes would be influential but this risky behavior carries on even today. The Fed remains unwilling to reverse its risky policy.

Which brings us to my last point before I sit down to a large bowl of JD. Yes, I know I forgot to mention JD in my last post and I got several angry letters from JD Distilleries worldwide. My last point is all this concern on the part of the Fed that without their continued hose full of money pouring on the economy, interest rates are going to rise to the stratosphere and the economy will come crumbling down. What gall. Does the Fed really have all that control over the economy? No and for several reasons.

First, all those traps listed above suggest the Fed often has little control. Second, there are huge money and financial markets out there that determine asset prices and rates in the USA and globally. If participants in those markets think rates are going to rise in the future, then they will make trades that push the rates up today. There is little to nothing the Fed can do to offset a major change in market psychology. Think of the little Dutch kid with his finger in the dyke. His T-shirt reads "I am the Fed."  In Dutch, of course. 

Finally why would the psychology change to make participants more certain that rates are going to rise? For one thing, the US economy is gathering steam. Among the many positive indicators was the recent announcement that labor costs are rising. All that money outstanding will eventually have to go somewhere. Some of the above traps will disappear – banks will make more loans, firms will replace decaying equipment, and households will buy more cars and JD. Firms will hire more workers. Prices might be under control, but there is no way for them to go except up. The best guess is for higher inflation and that too will drive up interest rates. This is not magic. This is what usually happens during an economic expansion. Rates return to normal with or without the Fed's love or encouragement. 

The Fed knows rates are going to rise and it can’t do a thing about it. It should give up this silly game of hubris and just back away. Pull that money out before it causes a fire! The longer the Fed waits, the more the negative backwash. Get on with it. The markets are ready for a return to normalcy. And I am ready for that JD.