Tuesday, March 31, 2015

The AIIB -- A Gift Horse in the Mouth?

The latest popular addition to the alphabet soup of global financial institutions is the AIIB, slated to begin operations this year.  Be thankful for this abbreviation as it stands for Asian Infrastructure Investment Bank. Drink three Old Fashions (made with JD) and then say Asian Infrastructure Investment bank 17 times while doing 11 burpees. See what I mean? AIIB is much easier. The name, however, is misleading and the new politics it brings is even stranger. Like not knowing which branch of Islam is the good one, understanding AIIB can be pretty confusing.

The first confusion is the term Asian. Calling this bank Asian is like calling any team with LeBron James something other than LeBron. Cleveland Cavaliers? Really? The AIIB should be called China and her friends. China will be the main stockholder despite being joined by almost 30 other countries. Key US allies are now trying to decide whether or not to join including Australia, Japan and South Korea. Britain, Germany, France and Italy have also promised to think about joining. The objective of the AIIB is to provide project loans to developing countries. These loans will focus on building infrastructure.

Since it will have representatives from all world regions it is hard to call this bank "Asian". AIIB is another Chinese development bank. Since the US sponsors similar world financial organizations with names like the World Bank and the Asian Development Bank (ADB), everyone knows these institutions are very much dominated by the US. Thus you can see why the US  is concerned when so many countries jump on China’s latest bandwagon. Are these countries with us or China? This reminds me of the grammar school basketball court when my team was unable to recruit the tall agile kid. The US feels threatened. 

We are hearing a lot about the AIIB mostly because we worry about our basketball team. No not really. Some US officials are worried that the AIIB will somehow steal our luster. But the truth is that worrying about the AIIB and China is a lot like worrying that the new handsome kid at school is wooing your girlfriend – when the truth is that she was about to dump you anyway.

Think about how we in the US sometimes think about the World Bank and and ADB. "There they go again  -- giving away our hard-earned money to creepy countries filled with graft, corruption and people who continue to insist on speaking foreign languages."  Yes, we are sometimes very upset that our money is not used more successfully by foreigners who rarely send a thank-you card. Or who sometimes forget to pay us back what we are owed in full. We should be thanking China for risking their renminbi in these same places rather than our dollars.

You are not convinced. You are worried that China will be better at this game than we are. You are worried that China will not only help these countries invest development funds more wisely but these other countries will then be so appreciative so as to shower their new Chinese friends with bouquets of Plum Blossoms and endless deep tissue Swedish massages. China and these developing countries will then skip off into the horizon holding hands and singing songs about Mao Tse Tung.  

But think about it a minute or three. First, China is facing difficult economic challenges. Their own development plans have floundered and growth is barely half of what it used to be. And even with all the past China Kudos, the average person in that huge country earns in a year about what the average American earns in 6 weeks. Okay China has some money to lend. But please – if the money comes with Chinese advice or partnership, are we really worried about competition from them?

Second, let’s get back to the girl who wants to dump you. We are less than appreciated by many developing countries. Why? We are nice guys and we look really good in Levis and yoga pants! One reason we are not fully appreciated is that they don’t always like our advice. It’s like when Mummy tells you to do your homework before you go online to Addictinggames.com. Or when Frau Merkel lectures Alexis Tsipras on financial management. When YOU want a loan you don’t appreciate the banker telling you how to spend it. These countries often do not like the US advice that comes through world financial organizations.

So she might dump you because she doesn't appreciate your advice. But the final point is to wonder why you liked her to begin with. Okay she has blue eyes and she dances like Madonna – but maybe she just isn’t your type. Look around the world. Developing countries are not doing well financially and in many cases once prospering countries replaced past rulers with “democratically” elected dictators. Do you prefer to dance with Cuba or Argentina? Columbia or Haiti? Maybe getting dumped isn't such a terrible thing. Buck up Charlie. 

The bottom line is that some of these developing countries are dubious candidates for our affection. If China wants to lead a brigade of unsuspecting lenders to steal the affection of the developing world it might help to notice that China has little to help them with and the developing countries have little promise to improve. If we are really worried about China then we should be gleeful about the fact that the AIIB will both weaken China, its partners, and all those politically delinquent countries who seem quite unhappy with US help. It is okay -- you may now do a happy dance. 

Tuesday, March 24, 2015

The S&P Express: Off The Rails or on Schedule?

Is the stock market over-valued? Are recent ups and downs the warnings of a weak future stock market? Can you overcook frog legs? Stockholders want to know answers to these questions.

Trying to forecast the future direction of the stock market is more impossible now than ever. So I am giving up on that and will try to explain why below. It is perfectly okay to punt on such things. Sure, there are snake oil salesmen who will forecast quite assuredly on any day at any time. But as they say – you gotta know when to say when. This stock market is wandering like an office worker on Tuesday night in Gangnam after one too many Soju.

I am going to use the S&P 500 index for my discussion below. I could have used any other major stock index and come to the same conclusions. Essentially these indices track stock prices of the largest American firms. They are measures of “da market”. The S&P 500 tracks the 500 largest US companies.

Today’s blog is more about the data and less about the theory.  I usually like starting with theory because it makes sense. For example, a stock is supposed to measure the value of the company. If investors believe that a company is doing much better these days and it has higher profits to prove it, then more people want to buy that stock. 

They buy it because they anticipate the company might issue dividends to the stockholders or they think the price will rise higher in the future. As they buy more of that stock the price often rises until the point at which people feel the price is high enough relative to its rewards.  If we are looking at the S&P 500, it often rises when the whole business sector is doing better – meaning more dividends and higher expected stock prices across the largest and most representative companies in America.

Stock prices may rise for many reasons. You might be unhappy when your local bank lowers the interest rate on your saving account to .00003%. So you take money out of that account and buy a share of the Jack Daniels Company. Any local or global event that induces investors to redirect assets away from other investments and into US stocks can cause the S&P 500 to rise.

That’s the end of my maco-finance lecture. The reason for reviewing some of this theoretical minutia is that there is plenty of difference of opinion about the future course of the stock market based on theory. There is ALWAYS plenty of difference of opinion among theorists about the market. There might be more now than usual but it seems to me the overpowering case for stock price uncertainty is not the theory. I think it is in the numbers.

Let’s suppose you have a friend and his name is Mabby. Let’s suppose Mabby weighed 150 pounds for the last 17 years. Knowing nothing about Mabby you might be quite confident that next December Mabby would weigh about 150 pounds.  Now supposed you had another friend named Abbmar. Abbmar weighed 150 pounds a year ago. Last December he weighed 350 pounds. In March he weighed 200. What is your best guess as to Abmar’s weight in three months? I am guessing you would have a lot of uncertainty about that prediction and you wouldn’t bet a lot on its accuracy.

That’s the way I feel about the S&P 500 right now. Most graphs of the S&P compare its value today to what  is was recently. Most geniuses compare it to a low point in 2009. Since then it has oscillated quite a but but the main story is its upward trend. But that little bit of history is very misleading since it looks at today relative to a recent low value.

So I decided to look at the S&P 500 going back to when it was just a little pup in 1950. I deflated all the monthly values for general inflation because you cannot compare apples and oranges or something like that. Then I graphed it. I could have calculated a bunch of really cool statistical numbers but sometimes just looking at the graph is enough. See the Chart below. (Note: The S&P 500 value today is approximately 2100. But when you deflate it by a CPI value of about 234, you get a number more like 8.)

·        From 1950 to about 1968 the real S&P 500 rose from a value of about 0.75 to about 3. The line looks pretty smooth despite there being plenty of ups and downs over those 19 years.
·        From the end of 1968 to the middle of 1982 the market was generally declining from about 3.0 to a low value of about 1.0. So we had about 15 years of a downward trend.
·        Then we had another time period of S&P expansion with few major downturns from 1.0 in 1982 to a value of almost 3.3 in early 1994. It took about 13 years but we got back to an old peak value of around 3.
·        In short we had three long cycles from 1950 to 1994 and the market value rose from about 1 to 3 in those 45 years.
·        Then it gets really weird. The S&P started drinking too much JD.  The real S&P 500 almost tripled from about 3 in 1994 to almost 9 in early 2000. The market dove from that peak of near-9 in early 2000 to just above 4.5 in early 2003. It reversed and went to above 7 at the end of 2007 and then to about 3.5 at the end of 2009. It is closing now again on 9. Are you seasick yet?

What can we say? First, we used to have long term trends in market direction that lasted for a decade or two. Now we have significant directional changes that last for at most a handful of years. Second, with those rapid direction changes go large percentage changes. A statistician might say that the standard deviation or variance has increased. Others might say the data is much more volatile lately. No matter how you say it – the market seems very unpredictable right now. 

Finally, even with all this craziness – it is not  easy to know what the most relevant previous peak is. The market hit 9 twice so maybe that is the new peak. But those peaks came after some unique situations and may have involved bubbles. One recent peak was squeezed between the 9s – of about 7.5. Today we are well above that one. There is also the previous high level of about 3. If that is the relevant peak then the market has a lot of room to fall in the future.

Being at or near the highest of the past peaks makes it hard for one to forecast anything good for the future value of the real S&P 500. So I did one more thing. I drew a line of constant 5% real growth from the peak value of 3.0 in 1994. ( See the red line on the chart below.) Today that 5% constant growth line produces a trend value of about 9.2 for the real S&P 500. Thus if we just erased a lot of crazy ups and down of the last 22 years and replaced all that with steady real growth of 5%, we would be at a value similar to what we experienced last week in the real S&P 500. In one year, it predicts a S&P 500 value of near 9.7.

So there you have it. Numbers don’t lie or do they? Much of my analysis suggests we could be in for a significant decline in the stock market. A trend analysis suggests the opposite. Of course, much depends on the theory. Are we really back to theory again? 

Tuesday, March 17, 2015

The Dollar Will Continue to Soar

There is probably nothing as widely quoted and least understood as the value of the dollar. It is sort of like your cell phone. Even children and grandparents have cell phones but most of us think there is a little Genie inside the plastic cover that makes calls by plugging little wires into large circuit boards.

Those of you who are not on a JD binge might have noticed that the value of the dollar has being soaring like Al Roker on Adderall. So let’s step back and try to understand what all that means.

The value of the dollar means nothing until we say – relative to what. A dollar has value as something beyond wall paper when you can trade it for something. You could trade your dollar for a Bo Jackson baseball card. $202 will buy one of those on the Internet right now. Or you could use your dollars to buy gold. An ounce will set you back about $1100 recently. You often use your dollars to buy JD, bread, toilet paper and other essentials of life. That cost is indexed by the Consumer Price Index whose value is 235.

Whenever the cost of the CPI, gold, or baseball cards rises - it takes more dollars to buy one of those things. Alternatively, a single dollar buys less – or it has less value.  Main point – the value of the dollar rests in its potential to buy things. When prices increase the value of the dollar falls – when prices decrease the value of the dollar rises. With oil and other prices falling in the US – you could say the value of the dollar has been rising relative to many goods  and services.

But there is more to this mystery. Another and equally frequent comparison is how the dollar trades for another foreign currency. We all know that most countries have a currency. We have the dollar but other countries use pulas, pesos, yens, wons, euros and so on. We can track how many dollars trade for these and other currencies. 

Recently a dollar could buy 121 yen. A year ago it could buy only 103. Thus we say the dollar increased in value over the past year because it now buys 18 more yen. That’s an appreciation of the dollar relative to the yen of 17%. The dollar rose in value against the euro by more than 20% in the past year.

A 20% change in the value of the currency if continued could cause major changes in the economic environment. When the dollar is stronger…
             It buys more euros and yens
            Thus if prices in Europe are quoted in euros and in Japanese prices are in yen and those prices remain unchanged, then a rising dollar is able to buy more European and Japanese goods.
            Likewise, Euros and yens can buy fewer dollars and so that means that Europeans and Japanese citizens find US goods and services more expensive.
            A 20% increase in the value of the dollar (decrease in the value of other currencies) thus tilts the incentives for buyers around the world. The tilt of a stronger dollar is to buy more of the cheaper goods in other countries and fewer of the more expensive US goods.

The above is the main reason why US policymakers face several dilemmas. US firms and labor unions will complain that the strong dollar is hurting their foreign sales. If this trend keeps up you can bet that more will be known about how US firms are losing competitiveness against global companies. Some will worry that all this will be enough to slow overall national economic growth. Thus policymakers will have to pay attention.

The value of the dollar – like any value – cuts in many directions. When the price of eggs rise, consumer hate it but you have to admit that egg sellers love it. A more powerful dollar means that US consumers, including companies, will be paying less for goods they import from other countries. So if you are used to buying electronics or clothing from abroad, it is likely that the prices of these items will be reduced. Companies that buy materials and equipment from abroad will also pay lower dollar prices. They will enjoy the ability to either expand sales at lower prices or increase profits. Like the price of eggs example – the rise in the value of the dollar helps some folks while it creates challenges for others.
Speaking of challenges it is important to keep in mind that US exporters do have options. The price a foreigner pays for US produced goods is also determined by the local price in dollars. So US firms harmed by a rising value of the dollar can recapture foreign customers by lowering the domestic price. This could harm revenue and profits but it does minimize the loss of global competitiveness.

I see it is nearing time for my JD break though there is much more to this story. So let me try to condense it. The rising value of the dollar is mostly the result of a redirection of world demand toward US assets. When the globe buys more US bonds, stocks, and bank accounts, this increases the demand for the dollar and its value. This geographical tilt in purchases of assets is caused by two key factors: monetary policy and economic growth. World investors are pretty sure that two things are happening and will continue to happen for a while. First, central banks in the EU, China, and Japan are determined to lower interest rates in those places – while the US Fed is recognizing that rates will have to rise in the USA. Second, the rest of the world is struggling with economic growth as the US economy improves.

The point of all this is that the value of the dollar is not going to reverse its upward trajectory any time soon because asset return opportunities favor the US. So we better get used to a rising dollar. One of my equally elderly colleagues told me at lunch this week over a lovely bowl of prunes that he could easily see dollar parity with the Euro in the near term – meaning the dollar may rise even more before it stabilizes. 

Tuesday, March 10, 2015

50 Shades of Grey: The Economic Report of the President 2015

A colleague of mine whose Stage Name is Dr. Bobby J alerted me to the fact that the Economic Report of the President (ERP) was published this February.  The ERP2015 is the latest in a long line of such annual reports that are widely available since 1995 when I was just a macroeconomist in diapers. Here is what the web site says about this annual publication: http://www.gpo.gov/fdsys/browse/collection.action;jsessionid=FKpBJ8tDXS8K1LZ8TlQvpC8sD7VGYWcnJs3yWr3DfJ2wXPJhXlJG!-1529450296!-1448731224?collectionCode=ERP&browsePath=2015&isCollapsed=false&leafLevelBrowse=false&isDocumentResults=true&ycord=0
The Economic Report of the President is an annual report written by the Chairman of the Council of Economic Advisers. It overviews the nation's economic progress using text and extensive data appendices. The Economic Report of the President is transmitted to Congress no later than ten days after the submission of the Budget of the United States Government. Supplementary reports can be issued to the Congress which contain additional and/or revised recommendations. Documents are available in ASCII text and Adobe Portable Document Format (PDF), with many of the tables also available for separate viewing and downloading as spreadsheets in Microsoft Excel (XLS).

I know – I am putting you to sleep. But for those of you who like to keep up with the economy, let me recommend this 414 page document for several reasons. First, it always contains an analysis of the past year and a forecast of the future economy. The 2015 ERP doesn’t say a lot about 2015 but does have a very complete forecast of the US economy for the coming 10 years. While you might not agree with the forecast, at least you see its composition and causal factors. 

Second, the document is full of historical data. There are charts, tables and figures in each chapter. Even better is the appendix which houses 26 historical tables. The latter makes it easy for you to research questions relating to past inflation, past unemployment rates, and so on. The 26 tables have just about everything you could want from GDP to wages to ownership of government securities.

Finally, the body of the report has several chapters that look into what the current administration believes are key economic issues and goals. The ERP2015 has chapters on Challenges in the US Labor Market, Business Tax Reform, Economic Benefits and the Foundation for a Low-Carbon Energy Future. These chapters contain the explanations and defenses for the Administration’s new budget proposals. These chapters are, of course, very political, biased, and incomplete.

50 Shades of Grey is a movie that my mommy won’t let me see. But I did some research and found that the term “50 shades of grey” has an interesting meaning. It means that any issue may have a lot of facets to it. And one can believe that because the issue is so complicated and multifaceted that one cannot easily come to a simple binary conclusion about it. Thus all the shades of grey mean  you can’t summarize an issue and say it is right or wrong; good or bad; hot or cold. Apparently there is something in the movie about whips and chains but I won’t go into that.

Interesting in the ERP2015 is the whole issue of income distribution. As we know, President Obama is very keen on improving income distribution. His speeches and what you see in the various chapters of this volume constitute a case for improved worker earnings. He also favors entitlements for the poor and middle class and higher tax rates on the rich as means to attain income equality.

While economists might favor the goal, some would argue about the means or ways. Some economists point to a trade-off between income equality and national economic growth. Others worry that Obama’s approach would create a larger and thus riskier national debit.

ERP2015 adds fuel to this discussion. The writers noted that there are three salient facts about US  economic performance – slowdowns in US labor force and productivity and widening of the income distribution. So the President’s economists did an interesting analysis. They asked what might have happened to the nation’s average income if each of these slowdowns had NOT occurred between 1973 and 2014. By doing this exercise we get some insight into the relative importance of each of these three problem areas. The shades of grey are:

            If the labor participation rate had not fallen, incomes would have risen by an additional $3,000 per person.
            If the income distribution had not fallen, incomes would have risen by an additional $9,000 per person
            If productivity had not fallen, incomes would have risen by an additional $30,000.

Can we conclude anything from this exercise by the President’s economists? I think so. While we could have raised incomes with policies that increase labor participation or income equality, the big dog in this contest is productivity. High productivity alone would have increased incomes by 58%. Productivity accounted for 72% of the improvements brought by all three factors. Economists do these kinds of analyses all the time but they are not beyond criticism.We have to recognize that this analysis is counterfactual. We are asking what might have happened in the past had one or more factors behaved differently.  Much depends on the models used. One could criticize this analysis on many counts. Even if the conclusions are correct for the past, that does not mean the same effects would be generated in the future. 

With these caveats, the black or white part of this is the overwhelming role played by productivity in increasing national income. This does not say that policies for income redistribution are wrong or bad – but it does establish a clear pecking order as we think about  the future.

While ERP2015 is clear about policies to improve these three factors as a means to increase national income, there is a clear bias in this report. The bias is in using government spending and regulation to enhance productivity. Another bias is ignoring any adverse impacts of income equality policies on productivity growth. Almost totally silent in these 400+ pages is any discussion of the known and published long-term increases in national debt – and how increases in national debt in the decade ahead will be a drag on national income.

Unrestrained entitlements, aggressive family-friendly workplace policies, expanded regulatory zeal in health and energy, and half-hearted business tax reform contribute to an environment of rising government debt and business uncertainty. The President is right to place his focus on rising productivity. But the debate is not so much about the goal but on how you get it. Too much policy emphasis on income inequality if it does have the above trade-offs promises to hurt all Americans. A more complete and less biased approach in this book would have been refreshing. 

Tuesday, March 3, 2015

Republicans Barking up the Wrong Tree On Trade and Money

The Republicans want to give the President fast track authority or what is also called Trade Promotion Authority (TPA). The Republicans also want Congress to have more oversight over the Fed. For a party that wants to limit the power of the President and the other party, these are very odd policy preferences. It is just fine to want more free trade and better policy from the Federal Reserve, but it seems to me they will get neither. Better to leave things as they are – at least until Republicans have more power and control.

Since the NAFTA in 1994 the US has signed Free Trade Agreements with 10 countries and one with Central America countries. Only three of the agreements – with Panama, Colombia, and South Korea – were signed during Obama’s terms of office. None of them amounts to more than a pile of pinto beans.  Even more interesting is that the so called Doha Round otherwise called the Big Momma of Free Trade Agreements has gotten nowhere. The World Trade Organization brings together 157 countries with the goal of reducing trade barriers and increasing world trade. The talks for the latest round of negotiations started in 1997 and a framework was finally agreed in in 2004. Yet despite continued work and much talk there has been no agreement. I have not seen any selfies of the President pushing for the completion of Doha.

In short, the President nor anyone in his party has a burning desire to consummate a chicken soup or a real free trade agreement. As in many other policy areas it is beneficial for a politician to say they favor freer trade, free trade agreements, and Mother Theresa but giving President Obama more freedom to negotiate a free trade agreement is like giving him authority to reject Islam in a mosque. It just ain’t gonna happen.

And Republicans ought to be smart enough to know that any free trade agreement that Obama supports will be something repugnant to most Republicans. One reason is that we are talking about Obama, the same guy they disagree with on almost everything! Another reason is so-called side-agreements. It is one thing to get a country to lower its trade barriers so that US goods are more easily sold there. But it is an altogether other thing when we have to reciprocate. Is Obama really going to advance an agreement that ends up reducing jobs of US steel workers? More imports from say China is always met with howls from Democrats about US jobs lost, environmental damage, and unfair practices of egg drop soup manufacturers. Addressing all the social and other collateral damages of a free trade agreement generally makes them impossible to approve and afford. Bill Clinton was able to escape many of these extras or else NAFTA never would have been successfully approved. Any FTA that the Democrats promote will be one that Republicans will kill or vice versa.  So why give Obama the power to move forward? 

Finally, I cannot image a worse time for countries to agree on trade. The EU is economically weak and its member countries are at odds with each other.  Asia is not exactly a love fest either. How about getting Putin, al-Assad, and Ukraine to sit at a free trade negotiating table? Worse, the US dollar is rising in value while most other countries are seeing currency depreciation as an important tool of demand stimulation. If Obama’s people harp on anything – it is how unfair foreign currency depreciation is to the US. So we will begin trade negotiations with the US wagging its finger at China, the EU, Brazil, and many other countries. Is this really the way you want to start a free trade negotiation? I don’t think so.

Larry take a big swig of JD. This gets us to proposals to shackle the Fed. After all we know the Fed is just a front for numerous conspiracies forged by rich people. Or else it is a liberal lapdog. But please think a moment, my legislative friends. Are you serious about having our democratically elected representatives have more supervisory powers over the Fed? These duly elected representatives are the same guys and gals who think that the best way to run a government is to shout at each other. If that doesn’t work then they shut down the government. Do we really want to give those guys the power to decide about monetary policy each month?

This is what is wrong with Republicans today. There is plenty to do without thinking up extraneous things. Giving President Obama fast track authority will either backfire or end up doing nothing. Giving Congress more power over the Fed is like giving the keys to the inmates (no insult intended to real inmates).