Tuesday, April 25, 2017

We are all Conservatives Now

We are all conservatives now! I knew that would get your attention. No, I am not into my third JD of the evening. But something is going on out there – or not going on out there – that supports my wild contention.

First, I am focused on financial conservatism – not the social variety. Second, I am speculating about conservatism as it plays out in macroeconomics policy. This idea has been ruminating in the dark recesses of my brain and jumped to the surface this week after I read one brief article online worrying over the uncertainty about US policy under Trump and then read another lengthier piece about the global economy by the International Monetary Fund.

The shorter Bloomberg article thought that stalling new policies for infrastructure spending and tax reform would injure corporate profits and lead to a slower economy. The IMF piece – a magnum opus on the world’s future output growth published this month – was more sanguine and predicted that the world and US economies would grow faster in 2017 and 2018. http://www.imf.org/en/Publications/WEO/Issues/2017/04/04/world-economic-outlook-april-2017

These two recent pieces see different futures but agree on one thing – it is the lack of traditional policy that underlies our economic futures. In macro, we learn two opposing schools of thought. The conservative macros believe good macro outcomes are the result of less government intervention. The liberal macros believe the opposite. The liberal macros believe that activism known as monetary and fiscal policy are necessary to rev up spending and will lead to full employment and strong economic growth. This liberal belief has become traditional. 

While the IMF often shows a liberal tilt in their outlook reports, much of what they say in the April installment is lacking in liberal spirit. From this I conclude that we are in a new economic policy conservative era – at least for a while.

While the IMF is forecasting marginal improvements in economic growth around the world, they mostly see an economy stuck in neutral and not ready for the next drag race. Summarizing from a long and technical report, the IMF describes an economy hampered by dismal expectations. The usual monetary and fiscal policies are having little effect on spending, and the more they fail to work, the more pessimistic we become. And therefore the policies have even less impact and we become even more dismal.

Low and negative interest rates spurred some activity in housing and autos but firms are sitting on their hands when it comes to expansions and modernization. Despite record amounts of fiscal stimulus, there is little bump to spending in the economy. The more the government lingers with these policies, the more dismal people become. The IMF wishes that governments could magically raise optimism. But how do you do that when the usual policies are not working?

What is refreshing is that the IMF is recommending some very conservative policies—policies that could be called supply-side. Imagine that. They admit that government is out of bullets. In fact they admit that there is already too much money outstanding and too little fiscal space (too much high debt) for most countries to resort to the usual policy practices.

The IMF names two major trends that are holding back the advanced countries. The first is a decline in the labor force participation rate. People are not wanting to work as much as in the past. Various reforms could help on that score but these reforms have nothing to do with the usual macro policies. They focus on the reward to work and on labor market mismatches. The second major challenge is in firms' willingness to buy new capital and to innovate. Firms are reluctant because of a dismal outlook but there are many ways that government can try to raise the return to capital without resorting to demand management. Reforms with respect to regulations and tax rates could go a long way to creating a more sanguine future for business firms. Raising the reward to work and to buy new capital will make firms more productive and profitable and should improve the growth rate of the economy. 

In addition to these trends are two global factors that dent our ability to grow faster. The first is recovery and reform in China. As these reforms start to work, China will resume its role as a locomotive pulling the rest of us along with them. Finally, there are the lingering impacts of commodity and energy prices. While we all love a low price of gasoline, the low prices of energy have stunted exploration and development of oil and gas. Emerging markets prospered with high energy and commodity prices. They tanked with low ones, and the contagion was global. 

None of the above supports a role for the usual liberal macro policies of monetary accommodation or fiscal expansion. In fact, making people more optimistic might involve admitting the ineffectiveness of these old tools – and thus we come away thinking that monetary normalcy and budgetary restraints are the key to optimism and spending. But better than that is the simple idea that policy should fit the nature of our problems. Right now our problems are from the supply side. Demand is low BECAUSE supply is low and because global challenges add to an uncertain outlook. Policies that directly target supply issues are what the IMF is recommending. What a refreshing change of message! 

Tuesday, April 18, 2017

Can We Kick the Budget Can down the Road Again?

We've kicked the can down the road so many times, we have a sore foot. This month our friends in the Federal government will create another ring in their circus called shutting down the government. It will be a colorful display of clowns before they get all serious and make another short-term compromise that will get us through the end of October. I'll drink a JD to that! Cheers.

The can-kicking has put us in one of those rock-and-hard place situations. We are used to the fact that government likes to spend more money than they raise from taxes. So each year the government borrows, and each year what the government owes to its creditors gets bigger. But a funny thing happened on the way out of the last recession -- our Federal Government Budget Deficit increased more than usual. And as a result, the US national debt has reached a size that we are not comfortable with. In terms of the size of the US economy, the net national debt is now double what it was way back in the good old days of 2008.

Put it on a personal scale. You have a large student debt. But now you want to spend the summer in Europe with your friends. Banks have your photograph in their lobbies, and you cannot borrow a penny for your business-class seat to Barcelona. Something has to give. You might have to sell your new car but you owe more than its worth. Or maybe you will need to get a part-time job. Ouch, whatever, the choices are not easy.

Republicans who want to spend more on X will scream about the stupidity of spending on Y. Democrats will decry the heartlessness of lowering spending on Y and the waste of more spending on X. Of course they could compromise on spending but it's more fun to wear a clown suit and honk horns.

As part of my therapy, I thought I might look at some numbers that compare the US to the rest of the world. Luckily, the International Monetary Fund publishes figures on government deficits and debts. In October 2016, they published a report called the World Economic Outlook where they looked at the world economy and made forecasts about the future. The table below comes from their online data appendices. The data for 2017 are forecasts made last October.

The table contains government deficit figures for selected countries. The column marked 2008 has deficits right before the great recession. The column marked Peak has data from either 2009 or 2010 depending on when the deficit was the biggest. The next column measures how much the deficit increased to the peak. Then comes the forecast deficit for each country in 2017 and how it has adjusted since 2008. Deficits are measured as a percentage of GDP for each country. Some thoughts from the table:

World investors are watching all these countries for signs of economic weakening. And with emerging market deficits rising so much, any hint of weakness anywhere has the potential to spook investors and move capital around the globe in gusts.

The US is a major country but is not exempt from investor decisions. Right now we don't look like the worst kid on the block. But if we kick the can down the road again while other countries appear to be more grown-up, then we may be amazed at how nasty those global investors can be. We won't be complaining about the value of the dollar being too high then.

Most countries had budget deficits in 2008. Most countries had deficits in that year though a number of resource-rich countries like Norway and Saudi Arabia had surpluses. The average deficit for advanced nations was -3.5%. The US was among a few with the largest deficits in 2008 with -6.7% of its GDP.

Then the great recession happened. This impacted the deficits in two ways. First, the weak economy automatically generated less tax revenues and more spending. Second, governments used expansionary policy to pump up the economy with more spending and less taxes. Notice the US had one of the largest increases from -6.7% to -13.1% of GDP.  Spain, Ireland, Russia, and a few other places managed to increase their deficits even more than the US.

The good news is that by 2017, most countries reversed their deficits. A combination of recovery from the recession and less accommodative budget policies brought deficits down. Most advanced countries will end up with deficits in 2017 that are smaller than those from 2008. The positives signs in the last column show the movements toward surpluses or larger surpluses. The average budget betterment for advanced countries amounts to almost 1% of GDP.

The more interesting and challenging part of the table relates to the developing or emerging countries. The table shows that their budgets were not quickly impacted by the great recession. But as the global contraction spread, they were increasingly affected. Emerging markets started with surpluses (0.8%) in 2007 which worsened to -3.8% within a couple of years and are expected to be -4.6% in 2017. Russia began the time with a surplus and now has a deficit. Venezuela, Saudi Arabia, and Libya each have extremely large budget deficits in 2017.

So what? While many countries have moved towards smaller annual budget deficits, the lasting impact of years of deficits is that most debt loads are larger. The US net debt load is now double what it was before the recession. Germany and Canada find themselves without increased debt burdens, but most of the other advanced countries have higher loads ranging from 30% for Italy to 140% for the UK.

2008 Peak Change 2017 Change
08 to Peak 08 to 17
Advanced -3.5 -8.7 -5.2 -2.7 0.8
USA -6.7 -13.1 -6.4 -3.7 3
Euro Area -2.2 -6.3 -4.1 -1.7 0.5
Germany -0.2 -4.2 -4 0.1 0.3
France -3.2 -7.2 -4 -3 0.2
Spain -4.4 -11 -6.6 -3.1 1.3
Greece -10.2 -15.2 -5 -2.7 7.5
Ireland -7 -32.1 -25.1 -0.5 6.5
Japan -4.1 -10.4 -6.3 -5.1 -1
UK -4.9 -10.5 -5.6 -2.7 2.2
Norway 18.5 NA NA 3.2 -15.3
S. Korea 1.5 NA NA 1.1 -0.4
Canada 0.2 -4.7 -4.9 -2.3 -2.5
Emerging 0.8 -3.8 -4.6 -4.4 -5.2
Russia 4.5 -5.9 -10.4 -1.5 -6
China 0 -1.8 -1.8 -3.3 -3.3
India -10 NA NA -6.6 3.4
Brazil -1.5 -3.2 -1.7 -9.1 -7.6
Mexico -0.8 -5 -4.2 -3 -2.2
Turkey -2.7 -6 -3.3 -1.6 1.1
Argentina 0.2 -2.4 -2.6 -7.4 -7.6
Venezuela -3.5 -8.7 -5.2 -26.1 -22.6
Libya 27.5 -5.3 -32.8 -43.8 -71.3
Saudi Arabia 29.8 -5.4 -35.2 -9.5 -39.3
Sub-Saharan Africa 1.3 -4.5 -5.8 -4 -5.3
Source: IMF Tables World Economic Outlook October 2016
Tables from B Appendix 
file:///C:/Users/davidson/Downloads/_tblpartbpdf%20(3).pdf

Tuesday, April 11, 2017

The Marx Brothers International Trade Policy

If you didn’t notice, two weeks ago we had some name-calling and hair-pulling in this quiet little blog. What fun! Chuck T posted a guest blog that argued against protectionism, and this energized the Tuna to take the other side. The battle was on, and I was among a few others who jumped into the fray. Along the way I was accused of being a two-handed economist, and after I figured out what that meant, I decided I needed to keep pursuing this topic. Two-handed economist indeed! 😊

The last time I looked, I had two hands. The issues of hands and economists apparently started when President Harry Truman got fed up with economists who couldn’t make up their minds and he demanded a one-handed economist who would not say on the one hand this and on the other hand that. He wanted someone who would take a firm position one way or the other. He realized that all national policy topics were multifaceted and wanted an economist who would weigh all the important elements. But he wanted someone who would then take a stand. Be on one side or the other!

So I am going to do that today. International trade and the benefits of trade are definitely complicated and multifaceted. No question. But this one-handed economist has little use for recently posed ideas about trade and trade policy.

But let’s start with the apparent problem with trade. Widely quoted data show that manufacturing employment in the USA has declined. They also show a deficit in our trade account and many stories corroborate that companies have moved their production abroad attracted by apparent favorable business conditions. These conditions might be lower wages or tax rates, but they also include closer locations to key parts of their supply chains, including materials or proximity to rapidly growing customer markets.

Some argue that policies that would thwart either imports of goods or the relocation of US firms will solve employment problems in America. A novel recent policy proposal would essentially make trade part of corporate taxes – wherein any export of goods from America would not be taxed while all imports would be. This pretty much reverses what used to be and would greatly favor firms that export from the USA. A second but complementary policy would somehow prevent other countries from depreciating their currencies so as to favor their exports in world markets while damaging US exports. A third policy would aim America-first principles at past and future trade agreements. Let’s call this set of three policies the Marx Brothers (Harpo, Chico, and Groucho).

There is much intuition to these polices. On the surface they seem to directly improve the situation. If other countries can’t cheat, this will help US export sales and jobs. If America matches subsidies given to exporters in foreign countries with similar subsidies at home, then those companies will have higher sales and employ more workers. If America penalizes companies for moving abroad, then even more jobs would be preserved at home. If past US trade negotiators “gave away the factory,” a new group of negotiators can get the factories back.

But just as a sticking one’s finger in the hole in a leaky dike sounds good in a moment of panic or frustration, such an act endangers the dam and all that live below it. What we need is a policy that works – not one that sounds like it might. So let’s think about what’s wrong with the three Marx Brothers.

First, economists who have studied the new tax proposal believe it will cause the value of the dollar to rise enough to offset the impacts of the tax incentives on the trade deficit. Thus, the desired remediation would be at best temporary. In addition, a permanent increase in the value of the dollar could make potential producers wary of locating in America, because it makes investment in the US more expensive. If they project a continued rise in the dollar that makes America a great place to import and makes it more expensive for foreigners to locate in America. 

Second is retaliation. A quick review of figures shows that US exports of goods and services is a mere 13% of US GDP. While we think this is large, exports are much more important to key trading partners. World Bank data for 2015 includes these ratios. Japan exports 19% of its GDP, China 22%, Canada 31%, Mexico 35%, Germany 47%, Vietnam 124%. Some might say Aha!  But that Aha! misses the point. These are countries whose medium-term survival is predicated on export success. They will not quietly nod as the US employs a new policy that threatens to harm their exports. They will retaliate quickly and with gusto. They will make it very difficult for their citizens to purchase US goods.

Third, it is possible that a new team of negotiators will do better with respect to past and future trade pacts. But keep in mind that the new team will be faced with increasingly motivated adversaries and a single unbending truth. The truth is that all sides to an agreement want the best for their own country. In doing so they have to make tough decisions because they know that every negotiation requires one to “give a little” to “get a little.” As in the above discussion about taxes and trade, the US is not going to be the only player in the room.  If the US wants to open services markets, protect intellectual property on foreign shores, or ask countries to reduce non-tariff barriers against US goods,  the US is going to have to give something up. If the US wants lower foreign tariffs on some of our manufactured exports, we may have to lower the tariffs on some of their manufactured exports. Whatever they choose, these negotiators will not be coming home with only trade benefits.

Finally we might need to come to grips with the idea that we are in a difficult transition, and whatever policies we impose to restore things to ways they used to be might work in surprising ways. Be careful what you wish for. 

We can close our borders to wonderful products produced abroad. Recall the cell phone took off when a Finnish company named Nokia made our lives incredibly better. We can make it unprofitable for US companies to locate abroad – when they are already not producing good results in the USA. Or by preventing our companies from locating abroad, we can deny them opportunities of innovation-sharing. If we are not careful, we will get what we ask for:  things like they used to in 1954. Aside from the TV show Father Knows Best, I think I like 2017 better. 

The Marx Brothers  and other America-first trade policies are most definitely not a slam dunk. Working to root out cheating. Trying to update relationships to current realities. These and other approaches are necessary, but even modest changes can backfire if not approached correctly. In today’s hypersensitive world with leaders who speak in riddles – even the smallest of changes can evoke recollections of Attila the Hun and reactions that go beyond the pale. Walking on egg shells is a better way to go. Meanwhile, we in the USA must figure out how a very rich country can grow and prosper as we fit into the world economy of the next 100 years. 

Tuesday, April 4, 2017

What's Up with Inflation?

Nathan and Brad are known troublemakers. The rest of their gang is well-mannered and even-keeled. I soon learned that I could understand and predict the behavior of the whole group by focusing mostly on Nathan and Brad. If Nathan had a few too many JDs the night before, then the gang would be quiet and slow the next morning. If Brad had been turned away from Night Moves the night before, the gang would be surly over Eggs Benedict.

That’s my take on inflation. Let me explain. The Fed awakened from its midsummer's night dream of slaying the unemployment dragon to discover inflation. Responding to an inflation rate in early 2017 that approximates the Fed’s goal for inflation, the Fed mightily raised the Fed Funds Rate by 0.25 points to a towering 1%. As my followers know, I have consistently implored the Fed to raise rates, so I should be happy. But alas, an economist rarely finds solace, much less happiness, as a practitioner of the dismal science. The rub here is that the Fed is doing the right thing for the wrong reason.
Returning to my opening paragraph, imagine that the gang started acting out. Someone not experienced with the gang would immediately point out the gang’s improper behavior and impose a harsh regulatory regime on all the gang members. But someone with more information would readily know the real cause of the problems – Brad and Nathan. As such, the appropriate remedy would focus on those two and not the innocent, sweet rest of the gang.
Okay, I am ready to be more specific. The Nathan/Brad nexus for inflation is the inflation behavior of two of the hundreds of prices of goods and services we buy in this country –  food and energy. The Fed has mistaken movements in the overall US inflation rate with changes in the prices of F&E. This mistake matters a lot – the remedies for a general rise in the nation’s inflation rate are very different than those associated with food and energy. For example, a policy to restrain buying of all goods and services might impact the prices of F&E. But surely that would be overkill as it would “punish” the whole gang of prices when they had little or nothing to do with the higher inflation.
Back up, Larry. What is inflation, and why are we concerned with it? Inflation is another one of those macro-thingies. Inflation measures how much the national price level is changing. Since most of us hate it when the price of JD or other necessities rise, we wonder about the course of the prices of most of the things we buy. Luckily, the Labor Department publishes the CPI each month, and we can oooh and ahhh about its ups and downs. When it goes up, we curse. When it goes down, we go to Tacos Guaymas and drink Tequila until we get acid reflux.
But it is not that simple. Sometimes a rise in the inflation rate is accompanied by rising employment and wages. That doesn't sound so bad. Sometimes it is associated with rising unemployment or what we call stagflation. That is not so good.
And worse yet, the CPI numbers are averages over many consumers. The last time I looked I was not the average consumer buying average stuff. In fact, if you know the average consumer, please have her give me a call. When the Labor Department constructs the CPI, they average together prices of food, beverages, fuel, recreation, education, Uber rides, and bunches more. But they don’t average all this equally. The prices of men’s golf shoes might have gone up by 1000% this month but men’s golf shoes are a very tiny part of what the average consumer typically buys each month – so 1000% has a very small weight and little influence over the CPI.
Here are some of the weights used to produce the CPI on various spending categories:
            Food and Beverage  .15
            Shelter                        .34
            Apparel                       .03
            Fuel for transport      .03
            Medical                       .09
So when the Labor Department averages prices in a given month, they pretend that the average person spent 34% of her income on shelter and 15% on food and beverages. Now let’s suppose you are on a diet that month and decided to live in a teepee. That month you spent a ton of money on your hair and nails and very little on everything else. Guess what. The price level may have gone up 3% for the average dude, but for you that would be very misleading.
General point. Inflation is a macro phenomenon and any month’s reading might have very little to do with changes in your welfare. The devil is in the details.
Let’s get back to the Fed. I looked at the data, and I think the lens is pretty fogged up. The Fed is mistaking an energy thing over which it has no control with a macro thing. They worry that inflation is rising but mostly what is happening in 2017 is that price change is returning to normal. From 2013 until the end of 2016, changes in macro inflation were almost totally driven by changes in food and energy. To be more precise, F&E were declining and were dragging down the average of all prices. Those low national inflation rates were not driven by national macro factors but instead by sectoral impulses originating in the food and energy components. Those impulses bottomed in August of 2016 and then turned marginally positive in 2017.
To be more explicit, what I did was look at the ratio of F&E inflation as a percent of total inflation (which includes F&E and everything else we buy). I won’t bore you with every month but below are a few data points from 2016 and 2017. In February of 2016, the annual inflation rate (from March 2015 to February 2016) was 1%. That’s a very low rate of inflation. But notice that prices of F&E were down 1.4% during that year. Thus the overall inflation rate was low because of the drag by F&E. You see similar results for most of 2016.

            Month               Inflation   F&E

February                   1.0      -1.4

            March                        0.9      -1.3

            September                1.5      -0.7    

For 2017, we have two months of data for January and February. Notice the much higher annual inflation rates in those two months. That’s quite a swing. But notice even more the swings in F&E from negative to positive change. For example, from September to February, the swing in the overall inflation rate was +1.3 points (1.5 to 2.8). The swing in F&E was from -0.7 to +0.6 or about + 1.3 points. Hmmm.

Month               Inflation   F&E

January                     2.5      0.3

            February                  2.8      0.6

Just in case you think I am cheating, the Labor Department publishers the CPI less F&E which tells you how much the prices of non-F&E goods and services change. Non-F&E prices seem to be stuck at about 2.2%. Over the 15 years from 2002 to 2016, they averaged about 1.9% per year. Is inflation higher in 2017, maybe a smidge.

Month               CPI w/o F&E

February 2016          2.3

March                        2.2

September                2.2

January 2017            2.3

February                    2.2

Point? Over the last several years, Brad and Nathan have been acting up like it’s Mardi Gras while the rest of the gang have been sleeping like babies. With regards to the overall economy, nothing much has changed. The Fed can’t do anything about food and energy prices. It should focus on creeping inflation of non-F&E prices but by no means is any of this heart-stopping. The Fed knows it should return its policy to normal. The recent rise in the inflation rate has nothing to do with all that. Interest rates of 1.0% are not normal. Gradually raise those rates and forget the inflation nonsense.

           

Tuesday, March 28, 2017

Navarro in Neverland by Guest Blogger Chuck Trzcinka

On March 6, Peter Navarro in the Wall Street Journal alleged that exports were good in the sense they promote economic growth while imports are bad.  He is the newly-appointed director of the newly-created “National Trade Council” which is evidently influential in the White House. Presidential advisors, especially Steve Bannon, espouse economic nationalism as a way to bring vigor back to the labor force. “Economic nationalism” means government interference with imports and help for exports. The G20 recently dropped its language against protectionism at the urging of the Secretary of Treasury, Steven Mnuchin. While macroeconomists have repeatedly criticized the logic and empirical foundations of economic nationalism, I think there is a simpler approach to this “intellectual” argument. Lets make some money off of these guys. I will travel to Canada where I will send Navarro – or anyone else in the White House--$10 Canadian. He can send me $20 US. His exports will be more than twice his imports making him better off by the logic of economic nationalism. If he is confused by currency and wants to trade products, I’ll send him a six-pack of Molson Golden--- actually five beers after I drink one—and he can send me a fifth of good Kentucky Bourbon which will also make him better off and will improve employment in Kentucky.
Where does this Alice-in-Wonderland view of the world come from? For Navarro, a recent Politico article (3/11) gives us a clue. Twenty years ago he was running for Congress as a Democrat and first lady Hillary Clinton campaigned for him. He was focused on the costs of international trade while completely ignoring the benefits and this sold in the Democratic Party. He spoke at the 1996 Democratic convention.  After he was soundly defeated by sensible Californian voters, he went on to write a book and produce a movie on how Chinese trade hurts the US. His book and movie got the attention of Trump who has also continually focused on the costs of international trade while ignoring the benefits. Navarro believes that China is manipulating currency by lowering its value with the intent to take over US production and control much of the US defense industrial base, threatening America’s freedom and prosperity. The mechanism of all this bad stuff is that the low currency induces us to buy Chinese goods which increases our imports and decreases our exports. Let’s engage in a thought experiment and suppose the Chinese were so successful at manipulating that we could buy everything in China for $100. China would be making everything for us and we would be making only $100 worth of stuff for them. All we would have left is our wealth. What we do with all our money? We could pay each other to write poetry while the Chinese would, according to Navarro, threaten our freedom. We would respond with sonnets. But we would be so wealthy that we could buy weapons from the Germans and hire Indians to protect our freedom from the manipulators.

The reality is that we have 200 years of experience with economic nationalism. Protectionism destroys the protectors and strengthens those who have the courage to trade. Every administration after World War II, knew this. These economic nationalists will leave a trail of economic destruction if they are successful, but before they figure this out, I want my fifth, Larceny Bourbon will do just fine. I’ll send them the five-pack of Molson. Your choice Navarro, put up or shut up.  

Tuesday, March 21, 2017

The Holy Grail and Mis-Trust Funds for Social Security and Medicare

I was recently part of an interesting discussion about government debt and current debates about how to control it. One side says that we cannot touch Social Security and Medicare spending. Those programs are too politically sensitive. Another side says that it is nearly impossible to control US federal debt without cutting these two important social programs. There are, of course, many other debates about the debt but I thought I would focus on this one today: Can or should we cut future spending on Social Security or Medicare?
First a little story. Then I will get to some data.

Nolan gets a part-time job and finds it impossible to spend all the money he earns each month so he lends the residual to Jason who promises to pay him back in 14 years. Jason spends the money each month. Fourteen years later, when Nolan asks for the money back and shows Jason his spreadsheet of past contributions, Jason agrees that the spreadsheet is impressive and that in fact he now owes Nolan enough money to go to college at Georgia Tech. Unfortunately, since Jason did not invest the money or any other money, he explains to Nolan that he is out of luck. Judge Judy saw otherwise and ordered Jason to find a second job so as to pay Nolan back what he owes him.

You might expect by now that Jason is going to shoot me. But this is not about Jason or Nolan – it is about the United States of America. Despite receiving very large sums of dollars for about 80 years from people paying into the Social Security system and other so-called trust funds, the US has nothing to show for it. Our government has done nothing but spend more each year than it receives in Social Security taxes and all other taxes. As such, instead of a shovel-ready-saving account the government now has a gigantic debt. Worse yet, all the annual balances of the major trust funds are either already in the red or are headed that way (see table below). Despite some funny accounting that shows trust funds with positive balances, there is no lock box and there is no money. It's like Nolan's spreadsheet.  
The USA now has to get a second job – or find a clever way to raise our taxes to keep the parade going.
Now to the data. Source is the Congressional Budget Office

The bottom of the table below shows projections of annual flows into and out of major US government trust funds. These projections are based on existing legislation. Notice that in four short years (2021) they will begin spending more than they take in each year. In 10 years, they will have combined deficits of almost half a trillion dollars each year hence. Notice that Social Security and Medicare explain all of the problem with trust funds -- with Social Security going into deficit by 2019. Medicare is already showing annual deficits. And yes, these deficits must be paid out of the general budget each year. That means more debt.  

The table also shows that the national debt held by the public (the gross debt is even larger) is going to increase by $3.5 trillion or 25% in the next five years. The annual rate of federal government spending will also increase by 25% or by close to $1 trillion per year in those five years. 

Notice that if spending control is to be used to slow or reduce the nation's debt, the choices are limited to make a noticeable impact. Nine of the 10 spending categories listed below will increase between 2016 and 2021. But the expenditure increases are small for all of those except for three. The increase in defense spending is expected to be $58 billion; for income security the rise is $19 billion. Compare those amounts to the much bigger increases for Social Security ($281 billion), Medicare ($220 billion), and Net Interest ($194 billion). Since the latter is unavoidable, we are left with only two real opportunities to make a dent in spending and the debt. 

No one wants to push old people over cliffs. But if one is sincere about managing the country's debt load, the choices are pretty limited. And notice again, we are not talking about cuts in any program. The annual amounts of spending for Social Security and Medicare combined will increase by half a trillion dollars per year by 2021. That's a whopping per year 31% increase in Social Security spending and 32% per year for Medicare. Don't tell me there isn't room to cut before it starts to hurt grandpa. 

10 Year Budget Projections
(in billions of dollars) 2016 2021 Change % of Total
Social Security 910 1191 281 30
Medicare 692 912 220 23
Medicaid 368 474 106 11
Healthcare Subsidies 42 85 43 5
CHIP* 14 6 -8 -1
Income Security 304 323 19 2
Defense 584 642 58 6
Net Interest 241 435 194 20
NonDefense Discretionary 600 641 41 4
Total 3755 4709 954 100
Government Debt 14.2 17.7 3.5
Held by the Public
(in trillions of dollars)
Trust Fund Annual 
Deficits and Surpluses
In billions of dollars
2016 2019 2021 2027
Social Security 30 -23 -96 -366
Medicare -6 3 -8 -90
Mass Transit 57 -16 -18 -25
All Trust Funds 314 72 -20 -454


*Children's Health Insurance Program

Tuesday, March 14, 2017

Lesson 0. Why Study Macroeconomics

Recently a friend who reads this blog blurted, "I like the blog and all that, but what am I supposed to get out of all your words?" Apparently I have been putting the proverbial cart before the horse. So I am creating one more lesson-style post and numbering it zero to communicate the idea that this is supposed to be the beginning of one’s journey with macro. This is supposed to be the equivalent of those first paragraphs of a first book on macro. And, of course, it is the hardest one to write. But I do have a full glass in front of me. 

One place to start is with the phrase forest from the trees. Macro has a lot of parts, or trees, but macro is bigger than the sum of its trees. Wikipedia defines macro as “the part of economics concerned with large-scale or general economic factors, such as interest rates and national productivity.” I read that and almost fainted. It breaks every rule of definitions. About the only words I understand in that definition are large and scale – and even those words are misleading. There are lots of large things (e.g. the Goodyear blimp and Refrigerator Perry) but not all of them are macro.

So let’s start over. First, macro is a science. Macro is a science because its main goal is to explain stuff and thus improve our lives. Physics is a helpful science because it tells you that after you throw a sharp dart up into the air, you should move or it might land on your head. Astronomy helps us to understand why the sun “comes up” each morning. Biology explains why eating too many extra-large Big Macs might not be a good idea. Science is our friend.

Macro is our friend too. It takes the economy of the country as its focus. While biology might focus on the whole body, macro asks questions like: How is the German economy doing? What’s up with Greece’s economy? While the concept of a body is very specific, the idea of the economic system of a whole country is less tangible. And thus macro is already in trouble. The doctor can touch your arm but the economist cannot touch the national economy. It is a figment of our imaginations. It exists only in our minds. And some of us have some pretty whacked-out minds. 

That sounds pretty bad. But the truth is that we use such counterfactuals for much good. You read fictional stories to your children hoping they will learn important lessons about life. Scientists stick millions of thingies on semiconductors that are so small that you can’t see them, and yet we are able to do amazing things with cellular phones and their apps. In biology class we experiment on fetal pigs, and despite the fact that they are not human beings, we learn a lot about human biological systems.

With macro, we can learn how the economy impacts our lives. The economy is like a train with many cars. Each car might be very different but when the train goes forward all the cars go forward. We might not be able to touch the national economy but we can try to improve its outcomes. At the heart of macro is something called GDP. GDP is not a tangible thing. It is an idea. It is defined as the nation’s output of goods and services. Think of a huge pile of goods and services and that is what GDP measures for given quarter or year. 

Every nation produces tangible goods like autos and JD. Every nation produces services that disappear the second you consume them, like when the Uber pulls away or the bartender moves on to serve another customer. Your drive in an Uber's Prius is over the second you step out. Okay, you might have a nice memory. In the bartender case you do have a lovely Old Fashioned but that drink is a good. The act of the bartender delivering it was the service.

In 2016 the US produced about $18.6 trillion dollars of goods and services. That's quite a pile! Can you touch that $18.6 trillion? No! You personally bought parts of that amount but the “whole enchilada” is the macro concept. GDP is like a basketball team. We cheer for it. Go GDP! Sure we have favorite players, but it is the team that we focus on year after year. In that sense, a basketball team is definitely not a tangible you can touch. It is a concept (and to many people, a very important one).

When GDP falls in a year, we call that a recession. We frown during a recession because we get less goods and services – and we dislike the fact that many people lose jobs as part of the contraction in output. We smile when GDP rises, and we clap when it rises faster than normal. Just as a basketball coach is expected to produce good results for the team, we expect our government leaders to create the right policies for growth of GDP. And like basketball coaches, even the best leaders win some and lose some. No one is a winner all the time.
  
I am just about down to the ice cubes. But I think I am almost finished. Macro is a science and as such is supposed to help us improve our lives. Macro uses concepts that are not always tangible but which are developed to help us think more productively about how to improve the nation’s economy. Macro devises policies and sometimes they succeed and sometimes they don’t. But like the meteorologist who missed the exact speed and location of a hurricane that came on land near Sanibel Island, the macroeconomist is constantly evaluating our macroeconomic science and policies with an eye toward learning from one’s mistakes.

Finally – since macro is about a whole nation – it is not about you or me specifically. Macro is not about Hoosiers versus Coloradans. Macro is not about workers versus owners. Macro is not about girls versus boys. Macro is not about JD or corn or oak barrels. Macro is not really about the rich versus the poor. The field of economics has categories to investigate each of those things, but macro tries to focus on the whole economy of a nation. When macro policy starts trying to be everything to everyone, it always fails at doing the one thing it is intended for – helping the economy to grow more so we all have jobs and more goods and services to play with!

Tuesday, March 7, 2017

Fumbling Around in the Dark

Fumbling around in the dark is a scary thing. You awaken at 2am in a very dark hotel room to find that you are relieving yourself in the closet. Or maybe you are trying to find the glass with one ounce of JD left in it, and you accidently knock your wife’s mobile phone into the toilet. Regardless, fumbling around in the dark can be pretty destructive.

Such fumbling is simple to explain. You are used to having light to guide your eyesight. Take away the light or the eyesight and you find yourself in a treacherous environment. Decision making becomes a totally new thing. You can do it but it necessitates new rules. It might require that you memorize the layout of your hotel room. It might mean groping with hands or buying a cane. How you operate depends very much on the expected time period of the darkness. A temporary situation would be dealt with differently than a permanent one.

It seems to me that the Fed is operating in the dark today. With Congressional economic policy in the potty, we rely on the Fed to guide the economy. Unfortunately, the lights went out in 2008 and the Fed has been groping around for ways to assist the economy ever since. In the beginning, most of us thought that the darkness would be temporary. Now I am not so sure. 

By darkness I mean that we have been dealing with economic problems and performance that are new. Our economic indicators are misbehaving. GDP contracted far more than during our experience of the last 75 years. US inflation bordered on the negative during those years. The Fed was correct to assume its role of lender of last resort. Economic darkness called for rare policies right after 2007.

But the great recession ended in 2009 and, according to my JD calendar, it has been eight years since we started an economic recovery. And yet in those eight years the Fed saw the same thing – economic weakness. And thus the Fed keeps its interest rate target at less than 1% and it leaves trillions of dollars in bank excess reserves. Why is the Fed so afraid to return to a normal monetary policy? Note I haven’t asked why they didn’t raise interest rates to 3-4%. I simply asked, why didn’t they start to return us to a more normal policy?

The latest answer is that they have already attained a normal policy. That is, the economists at the Fed looked into the darkness and drew a conclusion. Normal has changed! In particular, they resurrected a concept called the neutral or natural rate of interest. Aha – the neutral rate of interest has declined and therefore the current rate of less than 1% looks a lot more normal. 

What is the neutral rate and why is the Fed so confident that it dropped like a rock? Tuna – the neutral rate is not the neutered rate. To the rest if you – the neutral rate is an interest rate at which monetary policy is just right. As in Goldilocks, the Fed wants a monetary policy that is neither too cold nor too hot – they want it just right. If for example, the current policy interest rate (the Fed’s main policy target is an interest rate called the Federal Funds Rate) is 0.6% and the neutral rate is 4%, then we would conclude that the Fed’s policy rate is too low. It would also imply that the Fed is stoking the fires of the economy too much. But if the policy rate and the neutral rate are both around 1%, then Goldilocks kissed the charming prince and she and the frog live happily ever after.

As you can imagine, the Fed is relieved that it found economists who would explain why the neutral rate is low – and why it might stay that way until Nolan applies for Social Security. Not to contradict economists who work for the Fed, I will say that if they are wrong about this, then the Fed will continue providing stimulus to the economy long after it should have stopped, and the consequences could and probably will be a Fed-engineered bout of stagflation.

Could they be wrong about the size of the neutral rate? I think so. To conclude that the neutral rate is low, the Fed focuses on recent data that shows among other things a slowly growing economy. Such data includes declining labor force participation, a slowdown in productivity, and a discovery of new planets that might have doppelgangers for Barbara Streisand and Sara Palin. But can we believe all this?

I recall a very widely held concept called Secular Stagnation advanced by leading economists that explained why, after World War II, the US economy would slip back into the Great Depression. It never happened. Similarly, economists today look at data from a spoiled batch of milk. Whatever caused the great recession of 2008-09 and whatever unprecedented policies followed that decline appear to remain with us today. But just as turning off a light switch causes confusion for a while, the impacts of the last eight years will dissipate and then disappear. In the meantime our usual data are going to be very suspect, and thus our conclusions from such data will be equally suspect.

This darkness meant that the Fed had an excellent excuse to use emergency policies in the beginning of the recession. But it does not mean it should make up excuses to continue that policy forever. While the Fed is supposed to support full employment with stable prices, nowhere does it say they should engage in a binary policy of spigots open followed abruptly by closed spigots. The Fed does not know the value of the neutral rate. Erring on the side of a low rate to support its current aggressive policy means risking a future burst of inflation and an eventual Fed-induced recession. To mix metaphors – it is time to take the foot off the accelerator. 

Tuesday, February 28, 2017

Currency Manipulation Fairy Tales

More and more is being written about exchange rates. The US is accusing other countries of illegally manipulating their currencies and gaining unfair advantage in trade. Could this be another deflate-gate? Or is it just another attempt to deflect and persuade? In truth, most of us know little about exchange rates and wouldn’t know a manipulation if it twerked right in front of us.

So let’s begin at the beginning. The Lord created man and then the exchange rate. ... OK, not really. The modern exchange rate became useful after countries moved from barter to currencies, and people starting trading across borders. As you can imagine, Germans preferred being paid in dm (note: dm stands for deutsche mark. And yes, I know there are no longer dms or French francs or French fries). If Pierre wanted to buy a beer in Berlin, then he needed to swap some of his francs for dm. The exchange rate would determine how many dms Pierre could get in return for one franc. 

Let’s suppose a beer cost 10 dm in Berlin. If the exchange rate was 1.0, then that would mean Pierre would need 10 francs to acquire 10 dm, and therefore buy one beer in Berlin. Let’s now move forward and think of a hypothetical time after the French government flooded the country with francs. Now each individual franc is worth less. Now it takes, say, 20, francs to buy a beer in Berlin. If it took way too many francs to buy dm, then Pierre might not buy that beer in Germany, save his francs, and buy a Fischer's back home.

The above example illustrates the following. First, currency exchange is a common everyday practice relating to trade across borders. Second, the exchange rate is impacted by markets and governments. Third, in the above example a surplus of francs relative to the demand for francs can cause the franc to depreciate in value against the dm. Fourth, I can’t remember the fourth one. Oh yes. The depreciated franc makes foreign goods more expensive to Frenchies.

The exchange rate can be impacted by many events. For example, let’s suppose French people decide that French goods are inferior to German ones, and they shift their buying preferences toward German goods. If they are going to buy more German goods, then they will need to exchange more francs for dms. Thus the market value of the franc falls and the value of the dm rises.  

The above applies simple ideas about supply and demand to exchanges of currencies. If demand goes up for a currency then its value rises. We say it appreciates. Supply of a currency goes up and its value falls. That's called a depreciation.

WAKE UP. This is not over yet. The fun is about to begin. Let’s suppose you are a German and the value of the dm rises. You might have one of two reactions. If you love to buy French wine, you are very happy because a stronger dm buys more francs and therefore more French wine. If Juergen sells machinery to French buyers, he is very sad because now his goods cost more to French persons and he worries they will stop buying his equipment. Every time the exchange rate changes, some people are benefited while others are hurt.

That means that the value of a country’s exchange rate is always and everywhere a policy/political indicator. Since those who are hurt by exchange rate swings always yell louder than those cheering, we have an opportunity for politicians to ride in and save the damsel in distress.

So what can a good politician do? Ha ha – a good politician! I'll drink to that! Anyway, there are two typical ways a country can address an exchange rate problem. First, the country can intervene in exchange markets. If their currency is too strong and muscular, they print up lots of bright shiny notes and sell them in the market. Thus they acquire foreign currencies as they reduce the luster and price of their own. If their currency is instead weak and puny, they can sell the foreign exchange and buy their own currency from the markets, thus raising the value of their currency.

The second way to manipulate the value of a currency is through the use of monetary or interest rate policy. Compared to the first way described above, this approach is less direct yet just as effective. When the Fed engaged in all manner of monetary increase after the great recession of 2008/2009, the result was to reduce US interest rates, cause world investors to invest elsewhere, reduce the demand for dollars, and viola!, reduce the value of the US dollar. The Fed said this policy was necessary to stimulate the US economy by the usual domestic policy means. But the larger truth is that it was also aimed at reducing the value of the dollar so that US exports would be better priced in world markets. There is no question that the Europeans, Japanese, and others have caught on to this gambit and are now imitating the Fed. 

Let’s face it. If a country is facing a very weak economy or a recession, it is going to use one or both of these methods to stimulate its economy. The more important are exports to that country the more the temptation. Thus currency manipulation is like the last JD of the evening. You swear you will not do it and decry its worth, but once the party gets going and the Stones are on the Victrola, you are the first to pour one last nip.

It is truly ironic that the US is making such a fuss over currency manipulation when our own actions are so responsible for the vagaries of the high dollar today. It was us who used monetary policy to cause the dollar to swoon faster than a pelican above a catfish farm. It is again us today with our stronger economy and rising interest rates that now makes the dollar rise. To be sure, other weaker economies are contributing to the rising dollar with their own manipulations, but pointing a finger of blame at them is like getting mad at your children for raiding your unlocked JD cabinet while you are at open mic night at George and Wendy's. 

Tuesday, February 21, 2017

Repeal and Replace

Repeal & replace or repair. While there is importance to these words, they can be misleading. Sleight-of-hand is the tool of the magician ... and the politician and the subway thief. A band of entertainers enters your subway car and does magic tricks as their buddies relieve you of your wallet and other valuables. Those skilled at sleight-of-hand are never easy to anticipate and generate a lot of fun before they do their harm.

Repeal and replace gets the political base all fired up. Some people prefer to say repair but even that word elicits a political war cry. My eyes grow weary reading the endless minutiae. The Democrats will fight to the end over either repeal or replace. Republicans will argue the timing of the repeal and replace as if they were deciding which sit-com to watch first.

But stop sniffing a minute and realize that these words are there to inflame while the real issue is the improvement of the national healthcare system. D or R, we all believe that the system can be improved. Before Obama radically altered the system, most of us would have agreed that the system could be improved. And today, I think we know that healthcare isn’t perfect.

So why blab repeal and replace when what we all really want is improvement. Of course, we don’t agree on exactly what needs to be improved just as many of us held different opinions about Meathead in All in the Family. We are a nation of free thinkers. We love to disagree. Most bars would go out of business if we all agreed on everything.  

As we go about improving healthcare, it wouldn’t hurt to start out with some shared goals. We might not agree on the ways to reach those goals but let’s at least find some common ground. For example, most of us would agree that hospital gowns should have backs to them. No one likes a butt sticking out. And then there is the total avoidance of JD as a painkiller. That seems silly.

So now we have a place to start. Let’s move on. Another shared goal is access to healthcare. Let’s vote. Should we advocate limited access or wide access to healthcare? Everything else the same, let’s try to have a system that is available to most of us.

Second, let’s have a system that is affordable. Again it is easy to agree. Do we want a system that no one can afford, or do we want most people to be able to buy healthcare without selling the family's glug glug collection?

Third, to attain these goals we know there must be a mixture of market provision and government assistance. This is our tradition and is nothing new. We buy cars and cabbages in the free market yet we also have an extensive income supplement program for those with less capacity to purchase. We liberals and conservatives argue about the balance of market versus supplement but we pretty much agree that both are necessary.

Fourth, it doesn’t take Albert Einstein to understand that society must be able to afford this balance of market and supplement. Our hearts cannot rule our heads. Too much supplement doesn’t automatically make us Greeks but it could weaken our overall economic strength. 

Fifth, if the market is to provide healthcare then attention must be paid to the purveyors of healthcare – doctors, nurses, hospitals, insurance companies, pharmaceutical and medical device makers. There is no market without supply. Suppliers must want to provide their goods and services. At the same time, since parts of their earnings come from government supplements to the system, some supervision over their participation and prices is necessary.

Insurance will likely continue to be the basis of the healthcare system in the USA. Insurance markets exist in other venues – houses, automobiles, life and other financial products, and so on. Insurance has well-known principles. A major one is that many people pay into the system while others receive benefits. For example, good drivers pay for auto insurance each year and get nothing but piece of mind in return. But after some maniac who tries to change lanes with a margin of three feet going 90 miles per hour rams into you, then State Farm pays you to have your wrecked Lada replaced with a lovely Ford Edsel.

That’s the way insurance works. Some folks pay and some folks receive. If there are too few of the former and too many of the latter, then you have a problem. It makes absolutely no sense to let people enroll in insurance after they have a wreck. So any plan for health insurance in the USA will have to address ways to make people want to participate in the system when they are not ill. It seems to work for autos. I am not sure why we can’t find a way for healthcare.

It also seems related that people who find themselves out of a healthcare plan would be allowed to transition to another one. If someone has very serious conditions there should be an affordable way for them to find and keep insurance. Kids on parents' plans similarly need to be covered.

The above does not seem far out to me. Replace? Repeal? Keep your eye on the ball. We need a better healthcare system. Period. Healthcare reform always starts with something. Then you improve it. Now is no different from the past. Except for maybe the fact that people in both parties seem to have more fun screaming like banshees than actually doing something good for the country. 

Tuesday, February 14, 2017

Big Bang

Jimmy went in for his annual physical with Dr. Nolan. The doc shook his head and explained to Jimmy that he was going to have to change a lot of his habits: "Jimmy, you have a lot of things wrong with you. You are vastly overweight, anemic, diabetic, you smoke and drink too much, and your knees are about to go out under all the stress." Dr. Nolan suggested that Jimmy solve all those problems in one big bang. He would have to cut down on his visits to the Varsity, quit eating Key Lime pie, eliminate his 5 pm JD, quit smoking, and most important, eat more spinach, do more burpees, and have two knee replacements.

Jimmy was stunned. While he was willing to change his lifestyle over time, moving quickly on these fronts seemed impossible. How can one eat more spinach and not follow it with at least a tiny mouthful of luscious pie? And how can a human being cut out a daily ration of chili dogs without at least one puff on a cig or washing it down with a little JD? Worse, how does one do burpees without fully operational knees?

Dr. Nolan was insistent. "Jimmy, all these vices are connected. If you make headway on one, then you will just fall backwards on another unless you attack them simultaneously. Sure it will be rough for a while. But once you get past the first days, you will begin to feel like Melissa McCarthy on steroids." Jimmy replied, "Yes, Doc, but trying all that stuff at once might just demoralize me, and I might not even make it to my next appointment. And by the way, Melissa McCarthy is a woman."

Enough foolishness? I don’t think so. The idea of big bang versus gradualism is worth discussing in light of our new government’s volley of shots aimed at our country’s problems. I don’t have to repeat it all here but we have seen and heard policy announcements in many areas – healthcare, bank regulation, environmental regulation, tax reform, infrastructure, and so on. The rationale is that we have deep problems that are worsening. The explanation is that we cannot wait to attack these problems. Since many of these problems are related, it makes no sense to prioritize, because failure to move in one area means new policies in other areas will not succeed.

Is policy in 2017 like building a house wherein one must start with the foundation before erecting the walls? Or is policy more like making an omelet where you throw in all the fillings more or less simultaneously?  

Much was said about a big bang after the Soviet Union fell. Many countries were freed from Soviet policies and decided to move away from a socialist economic framework to one that was more capitalist. Some, like Poland, wanted to move quickly on many fronts. Hungary took a more gradual approach. (Hungary and Poland were not in the Soviet Union but were under its influence.) Others went even slower. I just read some of the economic analysis of these programs and policies and now have a headache. As you might expect there is no silver bullet to transformation. How one approached economic transformation depended on a lot of things including the nature of each country’s specific problems, its culture, and its history with socialism.

Countries that moved quickly and forcefully experienced very negative short-run effects including large recessions and high unemployment. Some that took gradual approaches avoided some short-term pains but followed a slower path to eventual stronger growth. It has been a quarter century since all that started, and the truth is that transformation goes on in most of the former Soviet sphere. The Baltic countries (Latvia, Lithuania, and Estonia) and Russia are the only countries to have annual real per capita GDPs of close to $20,000 per year. The rest are much lower.

The radical changes necessary to move from Soviet to market economies dwarf the changes going on today. Nevertheless, the experience of big bang is helpful. First, while there is some precedent for moving quickly on many fronts, there is also the recognition that gain may follow considerable pain. So one question is whether or not America in 2017 can tolerate a step backward. Second, much depends on the severity of the problems. Severe problems may be more entrenched and difficult to dislodge. A second question, then, is how bad are today’s problems in the USA? Third, results depend on history and culture. A past with experience in competitive markets helped places like the Baltic countries once they were freed from the Soviet Union. A third question: do US voters want to return to less government and more reliance on markets?

Are our economic problems in the USA today bad enough that people are willing to take a step backward to move the economy forward? Or do we even think these new policies are on the right track? It looks like a new big bang is about to start. The dust is about to fly.