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 

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.