Tuesday, December 29, 2015

Predictions for 2016

I offered no predictions last year and therefore I can honestly say that none of my predictions failed. But I knew that your holiday would be spoiled if I did not add a few tantalizing forecasts to those you will be hearing from real experts during the next week. So I am giving you 11 predictions for the price of 10.

1.     President Obama will announce a new directive in which Michelle his wife will become Queen for life of America. Congress and the Supreme Court are unnecessary obstacles under her regime so those pesky institutions will be disbanded.
2.     Marco Rubio will grow a whole foot next year and will tower over the other candidates at the debates at 6’6”.
3.     Iran, Cuba, and North Korea will form a new country named Korcuran. After their first practice shot with a nuclear tipped ballistic missile they will explain to western friends that they have no nuclear tipped missiles and would never aim them at Israel.
4.     Vice President Kerry will be scammed by third graders posing as fifth graders at a Kool-Aid stand.
5.     Carly Fiorina will be named most congenial from among the Republican presidential candidates.  Despite constant rumors she will not marry Matt Lauer or Hoda.
6.     Bernie Sanders will lose the Democratic nomination for President but will be among the top five candidates for emperor of Korcuran.
7.     Late starters, Dennis Rodman and Charlie Sheen, will win the Presidential election next November. Both are considered to be outsiders who will stand up for the little guy while being totally unintelligible. And possibly drunk. Queen Michele Obama will protest the election. 
8.     Delta and United Airlines will soon be marketing new standing areas on their international flights. While paying for all the usual amenities (baggage, JD, etc) flyers will now have to Pee for Pay in the lavatory. If a passenger cannot remain standing during the full 18 hour flight to Australia, he or she can pay flight attendants a little extra to tie them to their poles. Let’s not stand for that!
9.     The Indiana University football team will not play anyone in the defensive backfield next year. They have brokered a deal to have 15 players on the offense and only 7 on the defense.
10.  Net Neutrality will become the law of the land next year but most people do not have a net and are not remotely neutral. In a poll taken earlier this year 14 out of 10 people did not know what net neutrality means.
11. Obamacare will not be repealed. It will be renamed Rodmancare. Among the many new benefits will be a free week with unlimited healthcare in Korcuran and a discounted round trip airfare in Delta’s new Standing Zone.

I think I am running out of steam.

I hope you had a nice Christmas and 2016 brings you everything you ever dreamed of and more. And yes, send money if you can.

Tuesday, December 22, 2015

Santa, Trump, and Climate Change

That time of the year has rolled around again. Despite a mountain of evidence that Rudolph is really an ISIS spy using Santa’s sleigh to collect reams of personal information, we cut down perfectly good trees, decorate them, and go deep into debt so our children will carry on these traditions.

So naturally I was thinking about Santa when I read Bloomington's Sunday (a week ago) newspaper and came upon the column by notable left-wing columnist Eugene Robinson. The last time Robinson wrote a nice thing about a Republican candidate was when….hmm….I guess I can’t remember. Robinson, like about 2 million other nationally syndicated columnists, likes to write about Donald Trump. Articles about Trump now exceed the number of emails I receive purporting to help me enlarge my male part.

Here is what Robinson says about two-thirds through his article – “It’s not that Trump will do the impossible, it’s that he might do something.” It was this statement that got me thinking and that isn’t easy on a Sunday morning after the annual Christmas tree decorating party that included a brand new half-gallon bottle of JD. This statement by Robinson made me see the glowing connections between Santa, Trump, and Climate Change.

Let’s begin with Santa. We adults, except for Jason, all know that Santa brings no gifts with Rudolph and his sleigh.  As Robinson says, Trump won’t do the crazy stuff he yells about. But we love it when Trump reams the big guys. It’s like we all love it when IU almost beat Ohio State in football. We cheered like crazy knowing that our IU guys would not really win. We’d like to think that we might have won. That’s enough for Hoosiers. We love to tell our kids about Santa and Mrs. Santa and his workshop and shimmying down chimneys drinking milk and eating cookies. We love it because it makes us feel good. We love Trump because he say's things that most people would not say. 

That leaves us with another article that was published Sunday December 13 about climate change. President Obama was quoted in this article as saying, “The climate pact offers the best chance to save the planet we have.” I am not sure about you but the minute I saw that statement the first thing that came to mind was Supergirl. Don’t tell me I am not liberated!

There is a photo in that newspaper article with several key players of the United Nations with thumbs up and hands clapping. The title of the article is, “Historic pact to slow global warming is celebrated in Paris.” Ban Ki-Moon, not related to the infamous Reverend Moon said, “The Paris Agreement on climate change is a monumental success for the planet and its people.”

You would have thought that the representatives of 190+ countries had found a way to stop comets from intersecting with the Earth – or they had eradicated Aids or Pancreatic Cancer. Or maybe they agreed that Iran should name Christmas as an official holiday.

No, these representatives apparently did something monumental to save the plant from climate change. Already you are labeling me a climate change denier. That way you can dispense with me as just another fruitcake from the right. Never mind that. I am saying that you folks who are not climate change deniers have been duped in the usual ways by the usual people. If you care about climate change you were sold down the river by the 190+ smiling government officials.

These people punted every possible real issue. Folks there ain’t no Santa Claus and this agreement has done absolutely nothing to save the planet earth.

Your mom says "go do your homework". But she does not tell you when you have to do your homework. Nor does she tell you how much homework you have to do. Your mom says you have to self-report how much time you spent on your homework. But there are no penalties if you don’t do your homework. Maybe she will frown at you. You agree to do your homework when your friends do their homework but there is no mechanism for your friends to do their homework until they are 45 years old. Even then there are no penalties if they don’t.

No, I am not going to do the boring work of repeating all of the silly things in the agreement that are making so many people pop their corks. But here are a few examples of the silliness as expressed with the words of the contract:
By “some point” somewhere around 2050 emissions need to be reduced to low levels. I checked my calendar and Grandson Nolan will be almost 38 years old then. He is 2.5 now.
Countries are “expected” but not required to meet any targets
Since the agreed targets are insufficient, countries are asked to review them in four years to “see if they can update them.”
There are no penalties for missing targets
Richer countries “should” continue to support the poorer countries. China is “encouraged to pitch in on a voluntary basis.”

I think representatives of those 190+ countries should be asked to sign a statement that says that Santa is real and that Trump has nice hair.  We will then all feel a lot better.

Tuesday, December 15, 2015

Adam Smith and Prudent Man

Last week on December 8 the Wall Street Journal had two articles on page A15. In their Notable & Quotable column is a quote from Adam Smith from his “The Theory of Moral Sentiments” (1759). The second article is titled “Dissensus, the Spirit of our Age” by Joseph Epstein.

So today I am taking a departure from my usual Macro-paranoia to discuss the ways we speak to each other. My spell-checker does not like the word Dissensus but we all know what that means. It means we don’t agree. And when we disagree we are often emotional if not violent. I suspect that dissensus has always been around but to me it seems a lot worse today.

Perhaps our problems are more severe now – but I doubt that is the case. I recall too well being at Coral Gables High School and wondering before his horrible assassination if President Kennedy was going to start a war over missiles in Cuba. I remember the draft and Vietnam. I remember that blacks drank from separate drinking fountains and were required to sit in the back section of city buses. None of that was fun or good. We had plenty to argue about.

Yet despite the extreme and seeming intransigent problems we faced, many of us were able to find less strident ways to disagree. The Epstein and Smith articles ask us to think about this issue. Epstein emphasizes that people – even people with strongly held views – thought it more prudent to look at both sides of a question before leaping to vote for a candidate. Today many of us seem to have reflexively made-up our minds. Epstein thinks that we used to cogitate more and only decided after much weighing of facts.

Smith is copied below. His wording seems a little archaic and his descriptions of prudent man might be considered by some old-fashioned. But the father of the free market and the “invisible hand” says things we probably should not forget. Among the gems below are that the prudent man:
            studies seriously and earnestly
  may not be brilliant but they are always perfectly genuine
            is not ostentatious
            is simple and modest
            does not always think of cultivating the favor of those little clubs and cabals
 neither endeavors to impose upon you by the cunning devices of an artful imposter, nor by the arrogant airs of an assuming pedant nor by the confident assertions of a superficial and imprudent pretender.

More of Smith is at the bottom below.

Should we not passionately disagree? Of course we should. That is not my point today. My point is that we seem to rush judgment. We share with some others a complete and well-outlined ideology that has its own dos and don’ts. Am I saying you should not have an ideology? No. But what I am saying is that perhaps there are some important things that fall between the cracks.

One example is abortion. That topic has some of you already taking deep breaths. But in a democratic nation with divided views it is hard to  imagine moving to an extreme state in which we had either no abortion or totally free choice for abortion.  Today we have laws that allow it but regulate it. Realistically the laws will bounce around over time. Sometimes we will make it harder to get abortions for good reasons. Other times we will do the opposite – for good reasons. This is where the thinking comes in. If we are never going to move to either ideological extreme then it seems that knowledge and analysis ought to be used by both sides to decide on the best current solution. That hardly ever seems to be the case today. 

The same goes for income distribution or poverty programs. Extreme ideology supports widely divergent policies – virtually no social programs or greatly expanded state public assistance. Reality finds us between those ends. We can shout ugly epithets at each other – or we can be more like Smith’s prudent man. Would not a left-winger be willing to discuss waste in current programs? Might not the conservative believe that society could gain by assisting some families? The idea that knowledge and common sense can be brought together for our mutual gain seems valuable. The more important the policy topic the more important that we arrive at good decisions.

If we continue to go down the path of dissensus we will live by reality TV. Instead of prudent man we will live by the dictates of finger-pointing. It is hard for me to believe that we would continue to choose the latter.

Adam Smith, “The Theory of Moral Sentiments” (1759):

The prudent man always studies seriously and earnestly to understand whatever he professes to understand, and not merely to persuade other people that he understands it; and though his talents may not always be very brilliant, they are always perfectly genuine. He neither endeavours to impose upon you by the cunning devices of an artful impostor, nor by the arrogant airs of an assuming pedant, nor by the confident assertions of a superficial and impudent pretender. He is not ostentatious even of the abilities which he really possesses. His conversation is simple and modest, and he is averse to all the quackish arts by which other people so frequently thrust themselves into public notice and reputation. For reputation in his profession he is naturally disposed to rely a good deal upon the solidity of his knowledge and abilities; and he does not always think of cultivating the favour of those little clubs and cabals, who, in the superior arts and sciences, so often erect themselves into the supreme judges of merit; and who make it their business to celebrate the talents and virtues of one another, and to decry whatever can come into competition with them. If he ever connects himself with any society of this kind, it is merely in self-defence, not with a view to impose upon the public, but to hinder the public from being imposed upon, to his disadvantage, by the clamours, the whispers, or the intrigues, either of that particular society, or of some others of the same kind.

Tuesday, December 8, 2015

The Oil Glut Grows by Guest Blogger Buck Klemkosky

The International Energy Agency (IEA) has estimated that crude oil inventories have swollen to 3 billion barrels, the highest level on record, representing more than a one-month global supply. Many oil tankers, typically used to deliver oil, have been converted to floating storage with more than 100 million barrels of crude oil sitting in tankers offshore as the oil glut fills on-land storage to near capacity. The economics of storing oil for future delivery is no longer profitable as storage rates have increased dramatically, meaning some of the 3 billion barrels will be taken out of storage in 2016 and 2017. In addition, the U.S. strategic petroleum reserve is at its 720 million barrel capacity as well as China’s and other countries.

The oil glut has grown because supply exceeds demand by approximately 2 million barrels per day (b/d), 96.5 million b/d of supply versus 94.5 million b/d of demand. This is due more to supply increases than demand. Most major oil-producing countries have ramped up production including Russia, Saudi Arabia, Iraq, Iran and several others. Meanwhile, oil production in the U.S. has proven more resilient than expected although its 9.2 million b/d production is expected to decrease in 2016 but not significantly enough to offset increased supply from other countries, especially Iran as economic sanctions have recently been lifted. The growth of oil demand has increased by 1% annually over the last decade and growth is not expected to increase going forward. Much of the increased demand has come from China and other developing countries but their economic growth has slowed dramatically. Peak demand is now of more concern than peak supply.

The fall of oil prices (West Texas Intermediate) to less than $40 in 2015 will have repercussions for the U.S., some positive and some negative. The energy industry was the big driver of employment growth and corporate investment since the Great Recession of 2007-2009. Already $200b of global projects have been cancelled or delayed and more than 250,000 workers have been laid off. Two-thirds of the oil rigs in the U.S. have been taken out of service. The Keystone XL pipeline has been vetoed but that will not have much impact as the U.S. already imports 3.4 million b/d of oil from Canada out of 9.5 million b/d total. Overall lower oil prices will be a plus for importing countries such as the U.S. as lower gasoline and fuel prices put more money in consumer pockets. The real hurt will be felt by the major oil-producing countries and companies as all of the OPEC countries, including Saudi Arabia, are facing huge fiscal deficits. Forty North American exploration and production companies have already declared bankruptcy with more to come.

It is difficult to predict oil prices but the IEA estimates that the best-case scenario for oil prices is $80 per barrel by 2020 and the worst case is $50 per barrel. Geopolitical instability in the Middle East is always a possibility and Saudi Arabia has recently stated it would like to see oil stabilized at a higher price. But Saudi Arabia has not committed to cutting production to balance supply and demand which has been its role for several decades. If low oil prices are the new normal, the U.S. will be a net positive beneficiary as consumers will enjoy lower energy prices for several more years.

Tuesday, December 1, 2015

Export Doldrums: The Little Engines that Couldn't

Americans earn income when they produce things and get paid for the production. Our nation produces lots of things. Pfizer has been in the news lately because they are merging with another company. Pfizer makes Viagra. That makes a lot of people happy but I won’t go into that because some of our readers might take offense. We also make guns and houses and the list goes on and on. We also produce services. In fact the majority of what the nation produces is classified as a service. If you work at Macy’s you get paid the minimum wage or less to perform the sales function. If you are an Uber driver you get paid each time you deposit someone at a desired location like LaTorre’s Mexican Restaurant. If you sell tickets for cruise ship voyages you receive income so that people can gain about 50 pounds and see the shorelines of very interesting places.

In 2014 USA National Output or GDP was $17.4 trillion dollars. Wow. That is a pile of stuff! Of that amount $7.9 trillion was for consumer services and pretty much the rest was for goods sold to consumers and goods and services purchased by businesses and governments. In 2014 we imported goods and services of about $2.8 trillion and we exported $2.3 trillion.

It is those exports that I want to focus on today. Look at it this way – we produce stuff at home and sell it to people both here and outside the country. Let’s call the local buyers Pete and those offshore buyers Charlie. If we are US policymakers we want Pete and Charlie to buy a lot of US stuff. When they do that all kinds of good things rise – output, profits, jobs, wages, and so on. Please, no Viagra jokes. We have problems in the USA presently because neither Pete nor Charlie are on a spending spree. So the economy limps along.

I will pick on Pete another day but the question today is what happened to Charlie? And that’s what the next 117 pages are about. If you are in Colorado or Washington light up your favorite smoke and hold on. Otherwise JD works well. 

The first thing to keep in mind is that the US, unlike some other countries, is not dominated by export sales. That $2.3 trillion of foreign sales is only about 13.2 percent of GDP. If that figure was half of GDP then what I am about to say below would be alarming. But since export sales are 13.2% of GDP that means what foreign buyers do is important but it also means the 86.8% of local buyers are much more important.

But we talk about local buyers all the time so let’s spend a little time investigating foreign sales or exports.

Who buys our crap? Mostly people who are close by – Canada and Mexico are the two top foreign destinations for US goods and services. Together they bought $646 billion in 2014. That amounts to 28% of all US exports. Next in line were China and the UK. Below are the top 12 destinations for US goods and services. Together these 12 countries purchased in 2014 $1.4 trillion or a little over 60% of US total exports to the world.
            United Kingdom
            South Korea
            Saudi Arabia

If the US economy has been slowing down because Charlie is not buying as usual, then we should be able to see this in the data. So I compared two 8 year time periods for evidence of change: 2000 to 2007 and 2007 to 2014. It turns out that exports grew much slower in the latter period compared to the former. The next table shows the increase during 01 to 07, the increase during 08 to 14, and the differences. Data are from www.bea.gov 
US Export Sales to the World from 2000 to 2014.
                               0 to 7  7 to 14  Diff
Canada                   2297  1802     -495
Mexico                   1515  1068     -447
China                        897     345    -552
United Kingdom       773     645    -128
Japan                         760     735     - 25 
Germany                   531     421    -110
Brazil                        415     178    -237
South Korea              404     291    -113
France                        333    268      -65
India                           225      93    -132
Saudi Arabia              154      75      -79
Italy                            171    143      -28
   Total                      8474   6064  -2410

0-7 is the sum of US exports during the years 2000 through 2007
7-14 is the sum of US exports during the years 2007 through 2014
Diff is the difference between the first two columns
A negative number for Diff means lower export sales in 2007 to 2014
Numbers are in billions of dollars

The key point is that US exports have slowed dramatically. From 2000 to 2007 the US exported a total of $8.5 trillion in goods and services to the top 12 country destinations. From 2007 to 2014 we exported less, $6.1 trillion. The difference is not small -- $2.4 trillion! That is a 28 percent reduction.

While China explained about one-fifth of that seven year decline – notice that US exports slowed to every one of the top 12 country destinations. All 12!  Between our NAFTA partners Canada and Mexico we explain almost a trillion of the decline.

These declines do not come from one country or one part of the world. Economic problems in Europe, Asia, South America and even the Middle East all contributed to weakness in US sales abroad. As these countries suffer economic recessions and slow growth, their people are able to buy less. They buy less at home and they buy less from other countries, including the USA.

Next we turn to economic projections for these 12 countries. Expectations of stronger growth abroad would translate into a stronger demands for US goods and services. Below is a table I generated using economic growth data from the IMF World Economic Outlook (October 2015) Tables A2 and A4.

                    97-06  07-15  16-20
Canada          3.4     1.6       1.9
Mexico          3.3     2.1       3.1
China             9.4     9.1       6.3
UK                 3.1     1.0       2.2
Japan              0.9     0.4       0.9
Germany        1.5     1.1       1.5
Brazil             2.7     2.7       0.8
S. Korea         4.9     3.4       3.4
France            2.4     0.7       1.7
India               6.6     7.3       7.6
Saudi Arabia  3.9     5.0       2.7
Italy                1.5   -0.8       1.2
Average          3.7    2.8       2.8
Column 1 is the average annual growth rate of  Real GDP for each country from 1997 to 2006. The second column has average growth rates from 2007 to 2015 (the 2015 number is a projection for the year made in October of this year) and the third column averages the predictions for the IMF for the years 2016 and 2020. 

We see two things from this above table. First, the economic growth rate of the main US trading partners declined significantly after 2006. Every country except for India and Saudi Arabia (Brazil's growth rate did not change) slowed considerably in the 2007 to 2015 time period. This helps to explain the major reductions in US exports during those years. Incomes of our trading partners slowed or declined --- and they purchased less from the USA. 

Second, the IMF is not expecting things to improve in the next five years. The 12 country group's average GDP growth will not improve at all. Looking at our top three destinations only we see a big improvement expected in Mexico, a small gain for Canada, and a continued decline in China. India is expected to grow faster while Brazil and Saudi Arabia will suffer continued growth problems. 

Exports are not everything to the USA -- but they are important. If we believe the IMF's economic growth forecasts it is difficult to see any real hope for an export led resurgence of growth in the USA. As I wrote last week -- free trade agreements are the right thing to do but in this slow global growth environment it is difficult to believe that countries will approve a strong agreement and even with such an agreement, income problems will swamp any gains that might come from trade-opening agreements. The world needs a locomotive but it is unclear who will play that role.  

Tuesday, November 24, 2015

Conservatives and Free Trade

In the last Republican debate it became very clear that Republicans and conservatives do not all march to the same Gene Krupa. Republican presidential aspirants espoused widely divergent views on many subjects notably Syria, immigration, tax reform, and free trade. To note these differences is not a bad thing and knowing we have healthy debate means some thought and effort is going into important policy issues.

Today I want to focus on the debate about free trade. In the good-old-days of a decade ago or longer, I thought that conservatives favored free trade while modern liberals and progressives did not. You could count on Democrats to be against free trade agreements as part of support for labor and environmental issues. Republicans in contrast liked the efficiency and growth that came from expanding capitalism beyond ones borders.

But those simple differences evaporated. Knowing one’s party does not guarantee a position about free trade and free trade agreements. So I thought now is a good time for me to step back and says some things about free trade. The first thing to note is that free trade suffers from the same language inadequacy as say, free markets and free Internet. In all three cases there is no such thing as "free". In the latter case building and operating an Internet takes labor and capital and ingenuity. So someone has to pay for it. In the case of free trade and free markets, they only exist in the minds of economists and are less a real event or outcome and more a desirable though unattainable goal.

It’s like you wanting to fit into your wedding suit from 1969. That suit was long ago donated to some important charity but you have black and white photographs of you smiling and being totally unaware of what the next 46 years would bring in terms of large rib-eye steaks, mounds of mashed potatoes with gravy, and huge servings of apple pie-a-la-mode. But there is no reason that you should not strive to fit into a suit that resembles that one of long ago.

And that’s how I feel about free trade and free markets. Real markets have lots of warts. There is always someone or something that interferes. Find any book called "Introduction to Microeconomics" to remind yourself of all the assumptions that need to be met to yield the results of free markets. For one thing, no business firm can monopolize the market. For another, the prices and qualities of most goods and services must be known by the many buyers and sellers. And too, you don’t get the competitive outcomes if the Department of Labor tells the companies how much to pay the workers.

You can diet all you want but you are not getting into that old suit and you won’t have hair where hair does not grow anymore. But you can get close and the attempt to get closer can bring favorable results. Touching toes that you have not seen in decades is definitely a plus.

Economists prefer freer markets because the closer you come to having more competition and fewer trade impediments, the better chance you have of allocating resources in a way that benefits us. Free markets and competition drive prices to levels that give firms a normal profit and return on investment. These prices come closer to resembling the costs of production and thus do not waste precious resources. You pay pretty much what the stuff is worth. If it takes $25 to make a pair of yoga pants, then the market price of a pair of yoga pants is that $25 plus a normal profit for the firm that goes to repay the time and trouble to buy the materials, sew them, advertise them, and so on. A government that demands that firms price yoga pants at $1 per pair is going to mess up the supply chain. 

I can hear some of you closing your browsers and complaining – Come on Davidson, the world doesn’t work that way. Firms rip us off and the government adds layers of costs to protect workers, the environment, and Donald Trump’s hairdresser. And advertising – don’t get me started.

Notice that I said that there is no such thing as free competition. One firm recently tried to price a drug at hundreds of times what it cost to produce. Firms sometimes use a lack of competition to get much higher than normal profits. Lack of competition is what allows the worst outcomes including a horrible allocation of goods and services. 

We will never get rid of all barriers to competition. Corrupt firms will hide information and cheat in myriad and clever ways. Corrupt governments will use tax power and regulation to help their powerful friends gain advantages or to prostitute themselves for votes. But that doesn’t mean we can’t recognize all this and still promote freer competition.

The same goes for free trade. Free trade sounds terrifying to some people. Some say that Haiti cannot compete against the US. If we ask Haiti to reduce tariffs on corn, beans or wheat, you will hear the protests all the way to Washington. But please explain why the world has been moving towards freer trade since World War II. The World Trade Organization now has 161 members that agreed on major reductions in import tariffs and on other policies designed to reduce protectionist trade barriers. Or maybe you want to talk about the European Union’s 28 members who operate in a virtually single market zone where once there was a complex of trade impediments and tariffs. Freer trade and competition work and countries vote for it.

Also part of the real world beyond the corruptions I discussed above are real policy tradeoffs. Every country has a long list of goals that include ways that government intervenes and promotes growth, security, fairness, environmental quality, poverty, and many more. In the real world we recognize the benefits of freer international trade but have to compare those advantages to gains coming from pursuing other goals. It is no secret that the WTO has been working without agreement on its latest round of negotiations since 2001. The closer we get to reducing remaining trade barriers the more we seem to encroach on other national goals. It does not help that the world’s economy has been weak since 2008 – struggling countries care less about gains from trade and more about keeping the food on the table.

It is easy to see why a free trade agreement is so controversial today. Free trade is the right thing to do but it appears to jeopardize other goals. Some politicians will see an opportunity to accept a watered down trade agreement if it gives them the chance to advance other policies. Witness the 2000 plus pages and 30 chapters of the latest proposed agreement (TPP). It is ironic that those who often hate free trade agreements are so willing to sign one now. Equally ironic is that those who usually love free trade agreements see what is going on and don't want to be part of it. I guess the truth of the matter as it relates to free trade is what is contained in those 30 chapters and 2000 pages and if the trade-offs are worth each ounce of free trade advanced. It is okay if free trade Republicans decide that this agreement does pass muster.

Tuesday, November 17, 2015

Lesson 11 The Fed and Raising Interest Rates

You would have to be a starving artist or an ex high school football star to not notice that just about everyone is talking about the possibility that the US Federal Reserve is on the cusp of raising interest rates in the USA. Some of us like the idea of higher interest rates because we are old and want our saving accounts to grow faster. Others hate the idea because higher rates make it more expensive to borrow. And with less national borrowing those people worry that the economy might tip into another recession.

You can’t get into an Uber car or stand in the check-out line at Lucky’s Food Market without hearing people talk about the Fed and interest rates. So I thought it might be nice to sit here and sip and tell you everything I know about the Fed and interest rates. The first reminder is that the Fed has no direct effect on most interest rates. It is sort of like Uncle Bob. Aunt Cami can yell at Uncle Bob to rake the leaves. But Uncle Bob is Uncle Bob and he will rake those leaves when he is good and ready to do so. Of course if Aunt Cami yells loud and long enough she might influence him. And that’s the way the Fed works. The Fed cannot use an interest rate app to dial-up a mortgage rate or a car loan rate. 

Capitalists like me would say that interest rates are set in markets and are determined by the dynamic interaction of savers and investors. Or you might say interest rate changes arise from the interactions of bankers and other financial firms with the rest of us. Either way, you are acknowledging that rates on car loans or mortgages generally rise when people want to borrow more money. They fall when borrowers are fewer but banks are full of extra cash.

So what is it with the Fed and interest rates? Like Aunt Cami (and Uncle Bob), the Fed has a few tools it uses to influence savers and investors. The Fed can influence expectations by whispering they are planning to influence rates in one direction or another. That would be like Aunt Cami saying that she is growing impatient and is on the verge of yelling at Uncle Bob. Sometimes that works and Uncle Bob starts raking like a team of banshees. If that doesn’t work the Fed can go to Plan B or do what’s called quantitative easing and act as a very large buyer or seller of mortgages or other loans. Thus the Fed’s activity in the markets affects the supply and/or demand for assets – assets whose rates they are trying to influence. I am told that QE is not being used now. So that leaves us with something called the Federal Funds Rate (FFR).

The FFR is something akin to a quark.  Most of us will never see, smell or touch a FFR – unless you are a banker. The FFR is the rate of interest on a loan between two banks. Bank A has extra money. Bank B has a juicy new loan prospect but no money. So Bank A loans its excess to Bank B. Bank A charges Bank B the FFR. And we all live happily ever after. 

But what happens if all the banks want to lend to clients and none of the banks have extra cash? That is when Supergirl – er I mean the Fed steps in. The Fed buys government bonds from banks – thus adding liquidity or money to the banking system. This not only gives banks more money for loans but it also keeps the FFR low. As this amounts to a lower cost of funds for banks – banks can now keep  car loan and mortgage rates low too.

To raise interest rates the Fed does the opposite. To raise the FFR the Fed sells government bonds to banks – drawing money out of the system making money costlier. Bankers may or may not pass these costs along to people who borrow. But often it does work that way. So we say the Fed influences most market rates as it moves the FFR up and down.

In short the Fed can affect market interest rates and the world is watching to see if they will start raising the FFR this December. Lets suppose they do start doing this in December. How much will the FFR rise initially? How much will it rise in total over time? How long will the Fed keep the FFR high? One way to answer these questions is to look back at other times the Fed started raising interest rates.

So I plotted some FFR data – quarterly data – from 1980 to present. And here is what I found. See the table below for the details.
(1) Since 1980 there have been five times when the Fed moved to raise interest rates.
(2) Typically rates rose for 4-5 quarters but in 2004 the increase went on for almost three years (11 quarters). 
(3) Notice also that the rate at the beginning of the rising cycle was only 1.4% in 2004. During the four other episodes the initial rate was already pretty high averaging from 4.8% to 8.8%.
(4) The average rate increase in the first quarter  was about 54 basis points – or less than half a percentage point. For example in 2004 the rate was initially raised from 1.4% to about 1.9%.
(5) Over the full course of the policy period rates rose by an average of 267 points. The FFR increases were anywhere from 177 points to 382 points. In 2004 the rate started at 1.4%, immediately went to 1.9% and then over three years rose to about 5.2%. 

Year    #Qtrs Rate    Increase1   Increase2
1983      5      8.8      66                   259
1988      5      6.7      52                   307
1994      4      3.9      66                   208
1999      5      4.8      34                   177
2004    11      1.4      52                   382

Year is when the FFR began rising
#Qtrs is the number of quarters until the FFR declined
Rate is the value of the FFR at the beginning of the cycle
Increase1 is the number of basis points the FFR increased in the first quarter
Increase2 is the number of basis points the FFR increased before it decreased

The past can only be a rough guide to the future. 2016 will not be a copycat of any of these previous five cycles. It won’t exactly copy the past because 2016 will not be the same as the years before those past interest raising cycles.

But the past always informs and helps to put things into perspective. Rates do not usually rise by huge amounts and the tightening spells have lasted between one and almost three years.

At the end of 2015 rates are historically low and the world economy is barely moving along. Thus, market forces are not expected to present much pressure toward raising interest rates in the near future.  Most economists are predicting an initial FFR rise in the neighborhood of maybe 25 basis points. Should the Fed raise the FFR by 25 points in December or in early 2016 it does not follow that rates will swiftly climb in the next four quarters. In fact it is altogether possible that the 2016 cycle will be much more like the 2004 cycle than any of the others.      

The key takeaway is that the hullabaloo over when the Fed will begin raising rates is nothing compared to the anxiety that will arise once it begins raising rates. The drama will have only begun. Stepping to the open door of an aircraft flying at 12,000 feet is daunting but only the beginning of the story. 

Tuesday, November 10, 2015

The Common Cold or Economic Anemia?

Peter has had a cold for nine consecutive weeks. He is running out of Kleenex and good cheer. That’s a long time to have a cold. Peter looked back at his precise records. In the last 67 years he has had 10 colds. The longest one lasted three weeks. Most of them lasted only one week. Nine weeks? Maybe it isn’t a cold! Maybe Peter should be worried.

In similar fashion, Real GDP in the USA has grown by less than 2.5% for nine years running (if we count 2015 which is not over yet). This “economic cold” has lasted since 2007 just before the recession turned real GDP change negative. We have been blowing our collective economic nose every year since. Below are the annual real GDP growth figures (percentage change from the year before):

            2007  1.8%
            2008 -0.3%
            2009 -2.8%
            2010  2.5%
            2011  1.6%
            2012  2.2%
            2013  1.5%
            2014  2.4%
            2015  2.0% (based on 3 quarters)

If this was your kid’s GPAs for each term at Harvard, you might call the Dean and ask what is going on when your brilliant kid has such a mediocre record. The US economy is capable and expected to do much better. For example, the average annual growth rate of real GDP since the end of WWII is about 3.2%. Before the recession started between 1990 and 2006 – the average was 3% per year.  3% is an average of many years  -- during the past we have had recessions followed by strong growth periods many times. The average is not the best we can do. It is what one might call normal.

So I chose 2.5% for my analysis this week because it is clearly below normal. It might be a good rate for Germany or France of Japan – but it is not good for the USA. Nine consecutive quarters below 2.5% growth probably indicates that something is wrong – and that something is not the common cold or an allergy attack.

When you look at my table above – forget the two recession years when real GDP fell. Look instead at the years when we might have had a rapid recovery (with rates well above 3%) and then a sustainable growth phase. We had neither. In those 6 years the best we could do was 2.5% (in 2010). Look at the pattern – a little above 2% one year followed by a little below 2% the next. Those 6 post-recession years average to about 2% per year.

Our politicians seem to agree that this is not acceptable economic performance. But what galls me is that they are not really very serious about doing anything. When is the last time you saw Hillary or Bernie or any of the 92 Republicans shouting about the need to increase economic growth. While they will each say that growth is important, the energy behind a growth remedy is surely lacking compared to the many hot button issues that generate a lot of heat and light (abortion, gays, healthcare, income distribution, immigration, and so on).

This is crazy stuff because if you get higher growth – we take care of some of these problems anyway. Consider if we had grown in the last six years by 3% per year instead of 2% per year. That means real GDP would have grown to $17.3 trillion in 2015 instead of to $16.3 trillion (it was $14.4 trillion in 2009). Just having average growth in the US economy after the recession would have netted us an extra $1 trillion in income. That equates to about $3000 per person. I won't calculate the number of extra jobs but that number would be considerable too. 

Or put another way, this means that whatever is wrong with the US economy since 2009 is robbing the average family of four of about $12,000 each year. Is that not enough to get someone’s attention? 

Government dis-function is the culprit here. The pundits tell us each night that voters are mad as hell at failure in Washington. This trillion dollars of wasted energy explains why they ought to be angry. If candidate X really wants to stand out from the crowd -- he or she might run on a platform of giving them their jobs and a trillion dollars back. Democrats and Republicans approach growth from very different platforms and ideologies. That's okay with me. But let's at least make growth the heart of the debate. Let's at least have a debate. What is causing less-than average growth? How can we address those causes? This is not quantum physics folks. 

Tuesday, November 3, 2015

Triplets and the Tax Reform Blues

The WSJ on October 29th  featured an article by Republican Candidate Ted Cruz about tax reform. Cruz joins Jeb Bush and some of the other candidates in laying out thoughtful pro-growth tax reforms. We will be seeing more and more of these as we approach the coming presidential election.

While there is much to discuss and debate about the particulars of these tax reform plans, today’s blog post is more about the elephant in the room. Somehow these serious attempts to reform taxes and promote economic growth avoid or miss some important consequences and therefore make it very easy for the opposition to demagogue such plans.

It is no secret that income distribution and the national debt are twin ticking time bombs. Yet none of these tax reforms advance any serious if debatable discussions about how tax reforms might impact these issues. Democrats can’t do a sit-up without lamenting what has happened to the income distribution. Whether you agree with their policies or not, many of us wonder how long the economy can tolerate this apparent dislocation of wealth away from the poor to the rich. Clearly we do not want to be responsible for policies that exacerbate this widening gulf. But this is red meat for Democrats every time a Republican offers a tax reform program that skirts this issue. I don’t think Cruz’s recent article said one word about the effects of his program on income distribution.

Why? Perhaps it is because he wants us to assume that his plan will improve the situation. Economic growth lifts all boats. I agree with that statement but like many economic truths it is contingent. The truthfulness of it is related to other things happening in the economy. Doing push-ups is good for you. Give me 20. It will make you stronger and happier and sexier. But coach, I have a broken arm! Oops…maybe you should not do any push-ups right now.  So Cruz and the other tax reformers owe us a serious explanation for why their policies will not worsen and might even improve income distribution. If they don’t do it themselves – this leaves a lot of room for Democrats to make up outrageous stories. I can just see Hillary right now explaining how a flat tax is going to save billionaires zillions of dollars while the poor guy gets enough to buy a lottery ticket.

The other elephant in the room is national debt. Advocates of tax reform plans resemble the cheesy used car salesman promising that if you buy this plan you will grow hair and sleep through the night without one trip to the lavatory. As in the income distribution discussion, these Rs are whistling and crossing their fingers behind their backs while promising that a flood of tax revenues will flow over the dam. Lower tax rates mean tax revenues will jump higher than Michael Jordan on a trampoline. If debt is a problem, then these Rs need to do their homework and do some serious calculating about tax reform and debt. I would rather have them arguing about specific assumptions and elasticities than be such easy prey for the Ds. Silence is not golden.

Of course there is another approach that can work. Maybe Cruz and his playmates should admit that tax reform might not have a positive impact on the distribution of income and the debt. What? Larry are you nuts? Probably. But here is my point. The income distribution did not get out of whack easily. Maybe some serious thinking about the real causes of a poor income distribution would result in a serious policy aimed directly at those problems. Admit that tax reform is about growth. Tax reform cannot brush your teeth and walk your dog. An honest discussion and feasible policies to improve income distribution could go a long way politically.

The same goes for debt. Tax reform does not have to impact debt if it is tax neutral. It is a slam dunk that debt is not the result of deficient taxes but results from an incessant desire for government to spend more and more. Don’t hang your tax reform hat on the debt. Admit it has little to do with the nation’s crushing debt. And then have a separate program that goes after runaway spending. If you don’t think spending is running away just read my recent post “US Government: Liars and Thieves.“  Since I wrote it Congress decided to add another $80 billion on top of what was already a generous trajectory for spending.

So there you are. Tax reform is needed but it doesn’t stand a chance of passing if the good guys don’t couple it with serious approaches to income distribution and national debt. It is too easy to sabotage tax reform if nothing is said about these evil sisters. We might think about triplets. 

Tuesday, October 27, 2015

Trade Tantrums

I lamented in the last weeks that there are few voices in government to stand-up for budgetary and monetary control. This week my complaint is about international trade. Whether it is Trump or Sanders or Clinton – the story is pretty much the same. Americans are being hurt by free trade and we have to put an end to that.

This unified wail against trade is expected in slow growth times like we are living through. It is always easier to point the finger of blame and redirect rage at external forces. It is easier to do that than to admit that an economic behemoth like the United States can only linger in slow growth because of our own domestic policy failures. It might be comforting to some that the US is joining other countries in complaining about unfair competition. But it doesn’t help matters. Economists have long pointed to the disastrous effects of the Smoot-Hawley tariffs as a major contributor to the severity of the Great Depression. Protectionism can be devastating. 

As I showed in a previous post, the US has been hurt much less than other countries in the aftermath of the last global crisis. China is a shadow of its former self. Other developing countries that saddled their success to commodities trade are experiencing very slow if not negative growth. Europe grows slower than escargot. We complain when those countries allow their exchange rates to decline or engage in other emergency trade protection measures to resuscitate their economies. But the truth is that we in the US will gain much more than we lose if we ignore those misguided diversions from sanity.

So we ought to stop pointing fingers abroad and instead lead the world by example. And the example is to show that competition is good – whether it plays out domestically or in wider global markets. Since many Americans do not buy that story, let me work on it here today. The story has two parts. One is economics and common sense. The other part has to do with history.

Let’s discuss history and change. Most of us do not want to go back to the days when we washed our clothes by hand using tubs, scrub boards, and clotheslines or when we asked Mary the telephone operator to put our call through to Aunt Bee. We don’t want the textiles industry back in New England. We like modernity and most of us appreciate change that makes our lives easier and better. Transitions can be painful but in retrospect the pain has produced enormous gain.  

It is true that low skill manufacturing has all but disappeared in the US since the baby boom was born. But somehow as that was unfolding gradually over time, the economy grew and employment growth has been nothing short of spectacular. Much of the employment gains went to high valued added manufacturing and to services. And while services do include many low paid jobs they also include many very good ones in technology, scientific research, communications, health services, entertainment, energy, travel, shipping, tourism, finance, banking and much more. It surprises people that while manufacturing jobs have disappeared in the US, manufacturing output has not. US Manufacturing has grown at the same pace as the overall economy for the past 60 years. To say that manufacturing has disappeared in the US is wrong. Manufacturing has survived because US firms and locations have fought to maintain competitive.

Industrialization in America has been nothing short of spectacular as hordes of men and women have found good jobs and ample incomes. And while most of that process was domestic, part of that industrialization has been the phenomenon of globalization. It is the same process but it overlaps borders. No we don’t make many or any televisions in America anymore. How could we when an American factory worker wants to earn $50,000 per year and we can pay a Vietnamese worker $2,000 to produce the same TVs.

Vietnam is just one of many countries that offer advantages for low skill production. Somewhere around the early 1990s the world changed. Whether it was the breakup of the Soviet Union, the economic changes in China, or the demise of Latin American dictatorships and self-sufficiency programs – the next quarter of a century produced a dramatic increase in output and trade. Countries that never traded started to. Countries that traded only with their best regional friends began looking globally for markets.

That major historical change is not going away. And while it benefited the people in emerging market countries it also benefits us every day. We import goods that we could not possibly make as cheaply. We export to countries that need what we can make.  And investors have found new and successful global trading opportunities. If the US stock market is not making money for you – you can more easily buy emerging market stocks.  And vice versa. Call it diversification. Call it globalization. Or just call it good. 

It is true that in times like now when growth is so slow, our first instinct is to blame and protect. But it is also true that we cannot protect ourselves from dozens of countries whose inhabitants want to make $50,000 per year. The only way to truly protect our rich civilization in the US is to maximally exploit our advantages and opportunities. Do we not have world class scientists, companies, workers, infrastructure, and so on? Of course we do. No one should cry for America. But what we need to do is employ all our assets in ways that create competitive products and grow wonderful jobs. 

The future promises new and innovative processes, products, and markets. As people in emerging nations succeed and earn larger incomes, they will spend some of this new wealth at Apple, Microsoft, and Google. We need to focus on getting better and on how we can be the very best at what the world wants to buy. We do this by opening markets not by closing them. 

Tuesday, October 20, 2015

The Suckling Fed: A Central Bank Acting without License

One of the problems with monetary policy these days is that it seems level-headed and responsible and yet there is still something sadly wrong with it.  It seems correct and rational because the economy continues to have risk factors and we have a Fed with very powerful tools. So why not let the Fed continue to support the economy?

The answer is that while it all seems warm and fuzzy, there isn’t any real precedent or theory to support this kind of behavior. Pardon my little walk through history to make my case.

The Fed joined the central bank game in 1913. It didn’t have much to do during the Gold Standard days. After WWII we had something called the Gold Exchange Standard and the Fed was supposed to be pretty passive in that system too – though some people would argue that it was Fed activism that caused the US to have to embarrassingly admit they screwed up a very lovely system. President Nixon notoriously closed the Gold Window because we could not continue to honor our pledge to buy gold for $32 an ounce. We had depreciated the dollar and had to end the system or go broke.  

When I first learned monetary theory in the olden days of yore, there was a very simple idea that guided monetary policy. An economy needs money to make transactions. The Fed should make sure there is enough money to sustain a normal pace of economic growth. That was pretty simple. The Fed was not supposed to deliver babies or groceries or pizza. It was supposed to let money grow at a nice easy pace commensurate with long-run growth. Snore.

If you are still awake you might point out that the modern Fed has a dual mandate to keep inflation below 2% while pursuing a fully employed economy. That’s true but even those words do not support what the Fed has been doing the last few years. There is a difference between being a lender of last resort and being a lender of first resort. Let me explain.

Even some ardent conservatives believe the Fed should be the lender of last resort. That means that when we have an emergency that requires liquidity in the economy, most of us believe the Fed should provide that liquidity.  When the emergency vehicle comes to your house you are glad it contains a medical professional who will administer to your heart attack. The Fed performed that role in the beginning of the recent financial crisis. Give them a gold star. They did the right thing. It helped.

But just because the emergency doctor gets your heart going it does not mean you want her sitting in your living room watching reality TV and eating your butter drenched popcorn on a daily basis. Dude, go home. I am okay. Go help someone else.  

And that is the root of the problem with the Fed. Janet does not want to go home and leave us along. You might say – but she has plenty of support and authority from modern macroeconomics. Neo-Keynesians and even a few monetarists might agree that the Fed can provide stimulus and support for an economy entering a recession. The Keynesians have models that show a little bit of stimulus can go a long way. Monetarists might fret that such actions would cause higher inflation but both groups of economists admit that stimulus could be effective in moving us away from the worst of the recession.

But what none of them can show with or without models is why the Fed needs to keep suckling the baby. You and I know of mothers who are breast feeding their kids at age 14. Hey gal, it is time to give up on that. Enough is enough. I could not possibly do better than you in imagining all the reasons why breast feeding beyond even three years old could have some negative impacts down the line. Summarizing:

·        The Fed should be lender of last resort --- yes
·        The should stimulate the economy in a recession – maybe
·        The Fed should keep stimulating the economy until every last man and woman is employed – No No No.
·        The Fed should keep stimulating the economy until inflation rages --- No No No

Our Fed has absolutely no historical or theoretical support for what they are doing today. Can you name a time when the Fed successfully engineered the economy six years after the previous recession? They are freelancing in the worst way. Remember when the Fed chair used to meet with Congress annually and lecture the legislatures about prudent budgets and runaway debt? No longer. The ideal of an independent fiscally responsible Fed is sadly gone. 

Instead today what we have is a Fed that supports the government in its progressive agenda. What they are doing has no support in economics. What they are doing today is everything about progressive ideology. It is a sad precedent for the Fed and for the country. Maybe you haven’t noticed but despite all their so-called good work, the Fed remains skeptical about the economy. Instead they should admit that they are out of their province. Instead, they should be back yelling at Congress to fix what’s really wrong with the economy. They should be restoring more normal interest rates and money. They should leave us alone.