Tuesday, April 28, 2015

LGBTQs and Macro

Last week was very disappointing for me. I wrote a blog about a non-macro topic and it got more hits in one week than any of the 300 pieces I have written in the last five years. You would think I would be happy about that – but it tells me two things. First, nobody likes macro. Second, despite my hard work over five years many of you admitted to me that most of what I write you don’t understand at all. So you are outed – you don’t like macro and you think I stink at macro.

As my mother would say, Larry, eat your peas. She would also say make lemonade out of lemons. So I made some lemonade and that didn’t seem to help at all. Then I decided I would write a blog focusing only on things I know little or nothing about. That gives me a lot of leeway. But then I couldn’t think of anything to write about. Then I decided I would write a blog only on LGBTQ topics. But I wrote everything I know about that last time. Finally I decided to sip a little JD and then I hit upon a great idea. I will continue to write about macro topics and I will try to make them understandable to anyone over the age of six having a non-negative heartbeat.

I did that once. When Jason was a toddler in red sweatpants I wrote a series of lectures on macroeconomics for him. He went on to a degree in economics in college and excels at disagreeing with almost everything I write in this space. So that proves that I am capable of writing great things if only I try. It also shows that if I write about Ashley in one blog I have to say something about Jason in the next one. 

As a child and then as an adult I always loved Kraft Macaroni and Cheese. ChiliMac is pretty awesome too. My favorite song was Mac the Knife. So it was only natural that I would want to study mac-roeconomics. I was dismayed when I found out that macroeconomics was not food study and that it involved math, graphs, and something called variables. But I persevered. It took three universities and four degrees to figure out supply and demand. With that knowledge safely tucked under my beard Indiana University decided that hiring me was cheap and easy and letting me loose on students might not destroy more than a hundred years of academic tradition.

With all the above filler as an introduction I now turn to my true love, nude beer making. No, just kidding. I now turn to macroeconomics. Since many of you never completed a macroeconomics course and since most of you have forgotten whatever you might have learned in that course, I am now going to make things so crystal clear to you that when you read future blogs you will understand them perfectly and you will be able to explain those blogs to your friends and pets.

The place to start for you rookies is with anatomy vavava voom. Suppose you are going down the street and your friend says – Hi, how are you? You say, fine. That explains macroeconomics. In macroeconomics your friend is Canada and you are the USA.  Macroeconomics is all about the economic health of a country. Your friend then says – you don’t look so fine. You look like crap. Your GDP is sagging, your unemployment rate is flabby, and your inflation is barely beating.

You go to your doctor to get another opinion. He takes your blood pressure, temperature, and asks you to turn your head and cough. He looks at a bunch of indicators and uses them to explain why you look like crap. You feel better knowing that there are a bunch of things wrong with you. He then makes some outrageous guesses about what is causing your indicators to be so negative and gives you a prescription for drugs including Viagra. Or he might suggest that you go to a specialist. He then charges you enough money to pay for his next vacation on Jeju Island.  Yes, she will fly first class.  

Hopefully you are still awake and are getting the point. You look like crap. No just kidding. You look just like your Mother. Kidding again. The point is that macro is about the health of a country. Macroeconomists make huge sums of money despite taking the summers off by making up indicators that measure the macroeconomic health of places like the USA, Greece, and Oz. And like everything else on this planet we sort of know what is going on but we have lots of disagreements. What does it mean when your doctor says you are healthy? What does it mean to be healthy? There could be lots of opinions here. So we have a lot of indicators that must be evaluated.

The same is true of macro. There is no one single thing that determines the economic health of a country. So we mostly agree to analyze a bunch of economic indicators. One that gets a lot of attention is GDP or Gross Domestic Product. In class I usually refer to GDP as stuff we produce where stuff is a highly technical term meaning all that crap that passes for a good or a service. Then there is the unemployment rate which hardly needs explanation despite the fact that the US Department of Labor publishes a million different versions of it. The list of macroeconomic indicators grows from there including such spicy items as inflation, interest rates, exchange rates, earnings, debt, the length of Donald Trump’s hair, and more.

Okay – so for you literature and philosophy majors I will stop there. This is our introduction to macro. Macro is all about the health of a country’s economy. It includes numerous indicators when taken together can help you decide just how healthy the economy is. The implicit assumption is that once you make this judgment, you then try to decide WHY the economy is not at its peak health and then figure out WHAT we can do to improve it. That cause and effect approach will be covered more completely in lessons 2-768.  Or you could just go backing to listening to your favorite Jimi Hendrix song, Purple Macro. Okay admit it – Macro is very easy and cool. 

Tuesday, April 21, 2015

LGBTQs in Indiana

We who live in Indiana recently went through a disturbing experience with legislation that turned many a dinner table into a debate forum at best or a war scene at worst. This blog post is not about the legislation, its origins, or its impacts. It is more about me thinking out loud about something that both troubles and intrigues me. This process is both professional and personal.

It is professional because I spout off weekly and at least some of you take a minute to listen. I studied and taught economics for about 40 years and it is hard to turn that thing off. It is personal because I am coming out. No, just kidding. I am not gay. But my daughter is a lesbian. And a lot of her friends are LGBTQ. And a lot of my friends and colleagues are too. And some of my friends also have LGBTQ children.

This personal aspect has changed over the years. Like many people I didn’t know one LGBTQ person. As a young teen I was afraid to go into certain public bathrooms because my friends told me that gay men would accost me. That was the sum total of my knowledge. Of course, no one ever did accost me but that image hung in my head for many years. I remember once after pitching in a little league game, a young boy approached me and said he heard I was Jewish. I said that was true. And then he said – but Jews are devils and have horns. He was very confused. Point – when you don’t have any personal experiences, you can carry around some really weird ideas.

As LGBTQs have become more courageous and have come out in greater numbers, more of us see more clearly that LGBTQs are just like anyone else. Robin William’s portrayal of a gay man in Bird Cage was one of many important pieces of art that helped me see LGBTQs in a new and different light. Okay they are different in their sexual orientation. Jews won’t mix meat and dairy.  Koreans show respect by bowing and often the younger colleague pours the Soju for his senior counterpart. In some religions women are treated as less than equal. What is true about these and other groups is that we are all different.  But most of us share many common values – like love of God, practice of the Golden Rule, raising good children, having loving partners, working hard, etc.

For some who may not have had the benefits of knowing LGBTQs, you should realize they are as diversified as any other group you care to single out. LGBTQs have everything we have – smarties, dummies, many with very conservative life behaviors and others with very crazy and colorful lifestyles. I know LGBTQ realtors, fitness instructors, business owners, and academic administrator. My daughter’s lesbian friends are public radio hosts, cops, veterinarians, healthcare workers, and roller derby queens. Speaking of my daughter, she lifted a 72 pound kettle bell over her head with one hand while holding a JD in the other hand. I once employed a woman who did excellent layouts for my newsletter. Her partner is a retired IU professor. They have been together longer than most married couples I know.

Going on with this line of analysis should be unnecessary today. Knowledge and attitudes have changed. Most of us know many LGBTQs.  It is not respectful to them to have to make a point that we all know is true.

But this leads me to my main question. Why do some Christians insist that LGBTQs are sinners? Why is it that some Christians believe they would lose important religious rights if they had to cater a gay wedding? Why would they feel so horrible in catering this wedding, that it would undermine their own sense of spirituality?

One Christian friend told me that if a lesbian asked Christ to forgive her and if she renounced her sexual orientation, then she would be saved. Being a lesbian, he explained, is not the problem – it is acting as lesbian that is the sin. So if she stops that, then all is okay. But is it really okay? Yes, we want fewer divorces. Yes we want sinners to change their behavior. But is it really a sin against man or society if a loving LGBTQ couple dates, marries and does all the behaviors compatible with that love? If that is your personal belief then I won’t try to persuade you otherwise. But personal belief and public economic and business activity in a secular country are different things.

The Indiana legislation poked a finger into the eyeball of LGBTQs. I am not sure what impacts the amended law will have in the future. But I do know that it raises a very interesting question for the future. Can we really continue to think of LGBTQs as persons whose lives offend other so much that business or other laws can potentially be used to deny them normal functioning in society? I hope the answer is no. 

Tuesday, April 14, 2015

National Debt Insanity

My parents lived through the Great Depression. Like millions of others they were severely impacted and the experience shaped the rest of their lives. In the case of my parents they always distrusted banks and they rarely used credit. Anyone who has ever lived through a financial crisis – and there have been many across the globe and years – were similarly impacted and if nothing else they personally understand the unintended effects of debt.

For the rest of us who have not shared these painful experiences the stories and warnings of parents and grandparents seem distant if not wrong. We live in modern times and have institutions that are regulated and surely it is okay if we expand our uses of credit. Our President recently promoted the idea of much more credit for college students despite the fact that college loans are not only risky but are already growing faster than a dandelion in a Phinney Ridge lawn in April.

Students really need those loans. People have to mortgage houses. You will need a bank loan to buy that Prius. Some of us use credit cards because we often spend more than we earn in a month. Governments prefer to expand public debt because of many worthy projects and because raising taxes seems cruel to citizens. No one disputes the omnipresence and productive aspects of debt. But like a good JD poured over an extra-large ice cube sitting in the right whisky glass, something might be necessary but that does not mean there isn’t a possibility of overdoing it.

When it comes to our personal lives, many of us understand all this. And that means we realize that there is a limit to how much we can borrow. If you have massive student loans then despite a decent job the payments on a new house are probably out of range. There are practical reasons for keeping debt at bay. For one thing you have to make the payments on the debt. The more of your income that goes to paying interest the less you can use for that new Fender Startocaster or the expensive bottle of Pappy Van Winkle.  If debt goes high enough then maybe you will have to put off buying those yoga pants or a much needed mani-pedi (whatever that is).

Debt limits what you can afford to buy. But the issue of debt gets more dangerous than postponed gratification. What if you get laid off and cannot pay your mortgage? You may have to borrow even more money just to stay out of jail. This is a familiar story and we all know how painful it can be. With a smaller debt you might have endured a temporary job loss. Otherwise the options are not good. Look at current issues with Greece. There are no good answers for Greeks. Every option is painful.

With all these stories and realities around us, it is amazing to me that our government – the whole damn bunch of loonies – wants to subject us to unnecessary increasing financial jeopardy. Even Alex Trabek might balk at this kind of jeopardy.

What I am referring to is the current discussion about the US budget for 2016. Virtually no one in government represents the financial stability of our country. All branches and both parties have given the secret handshake and agreed that it would be silly to reduce the size of the US debt. Some Democrats have signaled they want to spend significantly more – particularly on Social Security Benefits. One fraternity of Republicans wants more spending on security and national defense. Another  wants lower tax rates and tax reform. But notice that none of them are seriously standing up for lower debt. Debt be damned or at least ignored.

Our government representatives take these positions knowing a few things. First they know that the USA is well into the sixth year of an economic recovery and expansion – one that has been lackluster at best. It is also one that will be followed by a recession. I don’t have a good gauge for exactly when recessions come, but surely within the next few years one will come. So despite today's higher incomes they don’t want to pay down debt. If not now, then when? During the next recession? I think not!

Second they know that national debt is much higher than normal. Okay – normal is not easy to define. But let’s face it – our national debt used to be about 35% of the size of GDP. Now it is twice that. Third, despite spending caps and tax increases on the rich, future plans are for the national debt to get even higher – more like 80% of GDP.

Hey Larry you are eating more popcorn than normal. What is normal anyway? Maybe 80% of GDP is just fine. So let’s talk about normal. The gross debt of the US is a big number but more meaningful for economic analysis is the debt held by the public.

The table below shows that we raised the debt dramatically during our last recession – notice the debt went up by 140% (from $5 to $12 trillion) between 2007 and 2014. But that isn’t apparently enough. From $12 trillion they plan another $8 trillion to reach more than $21 trillion. By 2025 the debt will be four times what it was in humble 2007. 

One benchmark for normal comes from our European neighbors. While some European countries are notable for large government debts (e.g. Greece, Italy, Belgium) countries that adopted the euro currency agreed to keep their net debts to less than 60% of GDP. That’s 19 countries who believe that there should be limits to debt. Most of them are usually well below the 60% figure.

So the US is well above most European countries. But the stupidity doesn’t end there. The Congressional Budget Office estimates how much more the debt will grow because of recent policy suggestions by both parties. Conservatively, the debt in 2025 could easily be another $5 trillion higher if government goes along with some of these ideas.

So – is a national debt of 80% of GDP too high? Will I be just fine if I add about 100 pounds of cheeseburger-induced fat to my belly? Maybe maybe not. But clearly the reasonable thing is to not go in that direction. Getting back to what we usually consider normal would create a lot less risk. No one wants another financial crisis tomorrow.

                Debt Held by the Public
            Year   In Trillions    % of GDP
            2007     5.0                  36.3*
            2014   12.0                  74.1
            2025   20.1                  77.1
*Note – between 1973 and 2007 the debt ranged anywhere from 24% (1974) to 49% (1995).

Tuesday, April 7, 2015

Paying for the Privilege of Investing at a Loss by Guest Blogger Buck Klemkosky

For the first time in recorded history, many European countries plus Japan have experienced negative interest rates. Government bond yields on short-term debt as well as debt up to 10-year maturity have turned negative in many countries, including Austria, Denmark, France, Germany, Finland, Switzerland, Sweden and Japan. More than 25 percent of European sovereign bonds sell with negative yields. Those governments can sell debt and get paid by investors for doing so. For investors, buying a bond with a negative yield means you won’t get all of your money back.

There have been many periods where real rates of return (inflation-adjusted) have been negative, but this is the first time nominal rates have turned negative. For example, if $100 is lent for one year with interest of 4 percent payable at the end of the year plus principal, the nominal yield or return, assuming annual compounding would be 4 percent. If inflation was 2 percent during the year, the real yield or return would be approximately 2 percent. If inflation exceeded 4 percent, the real yield would have been negative. This has occurred  many times and places throughout the world when inflation became higher than expected. This happened in the U.S. in the late 1940s, 1970s and recently in the 2000s. Bond yields reflect inflationary expectations, so unexpected or unanticipated inflation hurts bond investors as required yields go up and bond prices down.

What happens if an investor is willing to pay $105.50 for the same bond that pays $4 interest plus $100 of principal back at the end of the year? The investor is guaranteed a $1.50 loss and a nominal yield of -1 percent. If annual inflation was 2 percent, the real yield would be -3 percent. Why would investors pay $1.50 to lend or invest $100? Has the world turned upside down or have investors just gone nuts?

Investors would not usually lend or invest money at negative nominal yields if inflationary expectations were positive. But if deflation was expected, investors could still earn a positive real return. In the above example, if deflation was 2 percent for the year, the real return to the investor would be +1 percent. Deflation is good for bond investors because they are paid back in a more valuable currency that will have more purchasing power. If it is good for bond investors, deflation is bad for borrowers as they pay back interest and principal in a more valuable currency. Deflation usually occurs when economies are not doing well so it can be a double whammy for borrowers.

Deflationary pressures have plagued Japan for nearly two decades and Europe and the U.S. more recently. If not outright deflation, most countries have experienced disinflation, the slowing down of the rate of inflation. The consumer price index (CPI), sometimes called the cost-of-living index, measures on a monthly basis the cost of a fixed basket of goods and services purchased and used by a typical consumer. Typically, food and energy are stripped out of the headline inflation number, which includes all goods and services, because of their volatility and what is left is called core inflation. The difference between headline and core inflation numbers can be significant. In the U.S. for the 12 months ending in February, the headline inflation rate was zero, while the core inflation was 1.7 percent. For the 12 months ending in January 2015, the headline inflation rate was -0.1 percent. The Eurozone and other European countries have experienced deflation in both the headline and core measures. This has prompted most major central banks to target an inflation rate of 2 percent although this target has not been met for several years now.

Low inflation, deflation and deflationary expectations have been mostly responsible for the negative bond yields. Central banks have also played a major role, especially their impact on short-term interest rates. One consequence of the financial crisis and Great Recession is that central banks have loaded banks with excess reserves, those not needed to support loans and deposits. If banks do not make loans or invest, the excess reserves build up at the central banks. In the U.S., for example, excess reserves have increased from $20 billion in 2007 to $2.6 trillion today. The Fed pays banks .25 percent annually on excess reserves but the European Central Bank (ECB) charges banks -0.2 percent as an incentive for banks to lend or invest excess reserves. This negative 0.2 percent has put downward pressure on short-term interest rates here and in Europe.

A new regulatory environment has also impacted interest rates. In the U.S., banks must pay an insurance premium to the Federal Deposit Insurance Corp. The Dodd Frank Act requires insurance on nearly all deposits even though only those up to $250,000 are insured. The net result is that insurance premiums cost banks 0.2 percent annually on each dollar deposit and can be as high as 0.45 percent for a large bank with large deposits. J.P. Morgan recently announced that they will charge up to 5.5 percent on certain deposits meaning customers pay 5.5 percent annually for the privilege of depositing money at the bank, a negative interest rate for sure. J.P. Morgan and other big banks are obviously trying to eliminate high-cost deposits by charging fees for large deposits. This has further reinforced low and negative short-term interest rates.

Another regulatory factor is the new liquidity rules banks in the U.S. and Europe must cope with. Banks must hold high-quality liquid assets equal in amount to the deposits that may run or be withdrawn in times of stress. To meet this requirement, banks are investing in U.S. Treasuries and other sovereign bonds with zero risk of default. U.S. banks, for example, own $2 trillion of U.S. Treasury bonds. European banks are doing the same. Add in the amount of sovereign bonds the central banks own or will own and there is a shortage of high-quality sovereign bonds available for other investors, putting downward pressure on interest rates. The U.S. has experienced negative interest rates on overnight borrowing using U.S. Treasury securities as collateral because of their scarcity. The ECB quantitative easing (QE) program that just started in Europe plans to purchase $1.2 trillion of European sovereign bonds over the next 18 months. Many question whether this is even possible but it surely will be a drag on European interest rates.

European interest rates are lower than the U.S. because of a weaker Eurozone economy and the start of its QE program. This is true for the corporate sector as well where European bond yields are 1.5 percent less than equivalent U.S. yields. Nestle was the first corporation to have a negative yield on its debt, prompting a new slogan, “In Nestle We Trust.” Many U.S. corporations are rushing to Europe to issue new debt in euros to take advantage of these low rates. There may be more corporate debt with negative yields in the future.

Buying a bond with a negative yield does not necessarily mean investors expect a loss. Foreign investors may buy a negative yielding bond if they think the currency the bond is denominated in will appreciate, making money on the currency change not the interest yield. The Swiss franc has been unpegged from the euro and has appreciated considerably, which is why the yield on the 10-year Swiss government bond has been negative as well as Nestle’s. The strong dollar has made investing in the U.S. more attractive and has put downward pressure on U.S. interest rates. While it guarantees a loss if a bond is held to maturity, some investors may assume interest rates will be even more negative before the bond matures enabling them to sell at higher prices prior to maturity.

It appears that investors are more worried about “return of capital” versus “return on capital” and are willing to accept negative interest rates. Given the flight to quality, investors are willing to lose a little to make sure they don’t lose a lot.

Is the bizarre world of negative interest rates coming to the U.S? Probably not as the Federal Reserve contemplates raising short-term interest rates in 2015. There is a big divergence in global monetary policies as the U.S. tightens and Europe and Japan maintain loose monetary policies. The U.S. economy is doing better than Europe and Japan so higher relative interest rates are justified. But they may not move significantly from the historically low rates that exist today. Great for borrowers but repressive for savers. But it is strange and unprecedented historically to pay someone to borrow money from you.