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.